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Some stocks are STRONG BUYS when they fall
Other stocks are SELLS when they fall
How can you tell the difference?
Here are 5 financial yellow flags to help you out...
Other stocks are SELLS when they fall
How can you tell the difference?
Here are 5 financial yellow flags to help you out...
1) GOODWILL
This represents the premium a company pays for an acquisition above its fair market value.
If there’s lots of goodwill on the balance sheet, that’s troubling
This represents the premium a company pays for an acquisition above its fair market value.
If there’s lots of goodwill on the balance sheet, that’s troubling
If there’s a major goodwill write-down on the balance sheet, it’s a smoking gun.
When this happens, it means management has wasted a TON of capital.
When this happens, it means management has wasted a TON of capital.
Recent example: Teledoc $TDOC
$14B was a lot in goodwill to begin with. A $6B write-down is awful, too.
Buying Livongo at its price tag = HUGE mistake
$14B was a lot in goodwill to begin with. A $6B write-down is awful, too.
Buying Livongo at its price tag = HUGE mistake
2) Gross Margin Declining
Gross margin = (sales) - (cost of goods sold).
If I run a lemonade stand, it’s (money I earn) - (the supplies to make lemonade)
Gross margin = (sales) - (cost of goods sold).
If I run a lemonade stand, it’s (money I earn) - (the supplies to make lemonade)
Declining gross margins could mean
The competition is eating away business and I lower prices
People aren’t that interested in my product anymore
Either way, it can be a thesis-busting development
The competition is eating away business and I lower pricesPeople aren’t that interested in my product anymoreEither way, it can be a thesis-busting development
Recent example: Beyond Meat $BYND
The company's gross margin has been cut in half.
Some of this has to do with product mix (consumer vs restaurant buying). But it's not the whole story.
Meatless-alternatives are EVERYWHERE now (for cheaper prices)
The company's gross margin has been cut in half.
Some of this has to do with product mix (consumer vs restaurant buying). But it's not the whole story.
Meatless-alternatives are EVERYWHERE now (for cheaper prices)
3) Deteriorating Balance Sheet
This includes:
- less cash
- more debt
- higher inventory
As this happens, a company becomes more fragile.
This includes:
- less cash
- more debt
- higher inventory
As this happens, a company becomes more fragile.
Recent example: Peloton $PTON
In the summer of 2020, it had
$1.8 billion in cash
$0.5 billion in debt
$0.2 billion in inventory
Today
$0.9 billion in cash
$0.9 billion in debt
$1.4 billion in inventory
In the summer of 2020, it had
$1.8 billion in cash$0.5 billion in debt$0.2 billion in inventoryToday
$0.9 billion in cash$0.9 billion in debt$1.4 billion in inventory
4) Excessive Stock-Based Compensation (SBC)
Lots of companies pay their employees with cash.
On the surface, that’s smart – no money leaves the company’s bank.
Shareholders are diluted, but if it results in better results from happy employees – that’s a fair trade.
Lots of companies pay their employees with cash.
On the surface, that’s smart – no money leaves the company’s bank.
Shareholders are diluted, but if it results in better results from happy employees – that’s a fair trade.
However, sometimes, that compensation gets out of control. The dilution becomes excessive.
It also presents a problem: if the stock tanks, employees may want to be paid in cash instead of stock -- leading to booming operating expenses.
It also presents a problem: if the stock tanks, employees may want to be paid in cash instead of stock -- leading to booming operating expenses.
Recent example: Twilio $TWLO
Over the past year, SBC = 20% of revenue.
And it's steadily rising over the past few years.
Over the past year, SBC = 20% of revenue.
And it's steadily rising over the past few years.
The result: the number of shares outstanding is up 121% since the company went public.
Some of this has to do with an acquisition. But either way, long-term shareholders now own less than half of what they paid for a few years back
Some of this has to do with an acquisition. But either way, long-term shareholders now own less than half of what they paid for a few years back
5) Net Income is MUCH higher than free cash flow
Remember:
Net income uses accrual accounting. This smooths things out over time.
Free cash flow uses cash accounting. This is a more realistic narrative of money flows
Remember:
Net income uses accrual accounting. This smooths things out over time.
Free cash flow uses cash accounting. This is a more realistic narrative of money flows
If a company has much higher net income, it’s possible a cash crunch is on the way, leading to fragility.
When tough times hit, you want cash on hand – not promised by someone who may-or-may-not pay you back
When tough times hit, you want cash on hand – not promised by someone who may-or-may-not pay you back
Recent example: Netflix $NFLX
Over the past year, it has
Net income of $5.0 billion
Free cash flow of ($0.03 billion)
That's a difference of over $5 billion!
Over the past year, it has
Net income of $5.0 billionFree cash flow of ($0.03 billion)That's a difference of over $5 billion!
The problem:
If things don't work out as planned, the accrual accounting can't save you.
And that's what's happening
Competition willing to spend big on content is heating up
Subscribers are *leaving* the service
If things don't work out as planned, the accrual accounting can't save you.
And that's what's happening
Competition willing to spend big on content is heating upSubscribers are *leaving* the service
You MUST know how to find these yellow flags to be a long-term investor.
That's why @BrianFeroldi and I are excited to announce our first ever LIVE course:
The roster for open spots is only open for two more days!
Interested? DM me for a coupon code https://maven.com/brian-feroldi/financials
That's why @BrianFeroldi and I are excited to announce our first ever LIVE course:
The roster for open spots is only open for two more days!
Interested? DM me for a coupon code https://maven.com/brian-feroldi/financials
To review the 5 yellow flags
Lots of goodwill
Gross margin declining
Rapidly deteriorating balance sheet
Excessive stock-based compensation
Significantly more net income than free cash flow
Lots of goodwillGross margin decliningRapidly deteriorating balance sheetExcessive stock-based compensationSignificantly more net income than free cash flow
