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Red Flags

Wednesday, February 23, 2005 | 11:57 AM

Hewitt Heiserman, author of "It's Earnings That Count," (mentioned previously), weighs in on the exit strategy discussion from earlier. While I have a few rather different strategies use in temrs of price action, I particularly appreciate Hewitt's Fundie metthods of getting out of dodge:

Stock price

Sell 50% if stock drops 15% below purchase price; sell other 50% if drop 25%

Write down in notes sell points

Income statement

Earnings announcement falls short of consensus

(studies indicate the effects for as long as a year after the announcement)

Last two quarterly earnings growth slow

Other revenue rises without explanation (especially if company uses distributors for international sales)

Same store sales down 3% in last quarter

New store results are disappointing

Earnings miss unless a one-off, temporary problem (the first disappointment usually followed by another miss)

Company announces worse-than-expected earnings

Options, additional share offerings, conversion of convertible bonds result in massive dilution for existing stockholders

Strategic

Big price cuts on flagship products which does not result in market share increases

Company embarks on acquisition spree

Company buys another company in an industry they know nothing about

Company using acquisitions to bolster revenue growth

Change in business model; e.g., switch from all-company-owned store structure to franchise

Market is closing; e.g., Dayrunner organizers when PDA's became popular

Valuation

P/E ratio of 30, when most optimistic projections of earnings growth are 15-20% for next few years

Company sells at higher P/E than its growth rate?

No room for minimum 5% annual returns next 3-5 years

Is P/E ratio greater than 1.5x the market's multiple?

Technical

Relative price strength trending down

Company in a lagging industry as measured by industry relative strength (source: IBD)

No support at 50-, 200-day moving average

Is company breaking down badly and not rallying well vis-à-vis the S&P 500, Dow and Nasdaq?

(William O'Neil 4/04 issue of AAII Journal found when market leader finally tops, it will decline avg. 75%.)

Money flow or accumulation/distribution index deteriorate

Compare a stock's money flow on a relative basis and compare its current level to historical norms (Bloomberg, BigCharts)

Industry market leaders are topping out

After months of significant price advance, a stock runs up faster than normal in just one or two weeks

Stock shows downside gaps, usually indicating many institutional sellers present.

Stock exhibits deteriorating relative strength, suggesting the stock is beginning to lag the overall market.

Earnings fall short of expectations or fundamental strength deteriorates.

Stock

Splits for the second time in less than 12 months

Secondary offering priced at discount to current stock price and carries warrants that can dilute EPS even more

(Sharp underperformance of companies following secondary issue)

Private offering in convertible notes because it dilutes earnings per share

Company with large cash flow keeps buying its stock back at rich multiples as growth in organic revenue slows

Management

Best story is stock performance rather than business.

Top executives and some key employees go to rival firm

New management team that hasn't proved its bona fides

Business conditions described as "challenging"

Investment banker hired (are they trying to protect their cushy jobs?)

Company files extensions for reporting earnings

Other

New competitors entering the market?

Customers changing spending habits?

Price war erupted in industry?

How are other companies in same industry doing?

(Red flag when one company in industry doing much better than its peers)

Cut losses short, as they can be overcome. Big losses do severe financial/psychological damage that are harder to recover from.

Stores

Decline average weekly stores sales

Other:

Management significantly reduces sales, earnings forecasts

Competitor says business is tough

Negative same-store sales growth

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Comments

Something wrong with the formatting here. I am having a hard time in Firefox on OSX. Just this last post.

Posted by: jjr | Feb 24, 2005 4:47:25 AM

SandSpring LLC has updated it's website which seems to suggest that the 'domed house' part of the '3 peaks and a domed house' may now be nearing completion. Curious to hear of your take on their commentary and whether you are still sticking to your earlier predictions for a final push higher by the market in early to mid 2005 before heading down ?

Thanks very much.
-an.

Posted by: an | Feb 28, 2005 2:27:44 PM