9 signs your ASX company is heading to the wall

One of the most important factors in outperforming the market is avoiding the losers. There are several warning signs you …

a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

One of the most important factors in outperforming the market is avoiding the losers.

There are several warning signs you can look out for that may indicate your company is heading for trouble. While companies can still report rising revenues, profits and earnings per share, they may still be on the slippery slope to oblivion.

9 key indicators to watch for are:

  • Falling profit margins
  • Negative free cash flow – paying out more in capital expenditure than it received in cash from ‘business as usual’
  • Frequent capital raisings
  • Falling returns on equity, assets and capital
  • Rising cost of doing business – costs of raw materials, employees and other costs increasing faster than revenues
  • Rising levels of debt
  • Falling interest cover – the size of a company’s profits compared to its interest costs
  • Rising or very high levels of intangible assets
  • Frequent reporting of negative “one-off” items

The following companies provide ample evidence that these indicators can be used to pick the weeds from amongst the flowers. While a company exhibiting one or two these “symptoms” infrequently may not be heading to the wall, investors would be wise to consider them potential warning signs.

ABC Learning

ABC Learning was a classic example of several of these factors occurring at once. The company was reporting rising revenues, profits and earnings per share but its EBIT margin, net profit margin and return on equity were all falling.

Free cash flow had been negative from 2002 to 2007 and the company raised significant amounts of new equity every year with the share count going from 45m shares in 2000 to almost 400m shares on issue in 2007. Debt ballooned to $1.76b in 2007, eventually bringing the company unstuck.

Timbercorp

Timbercorp is another worthy example. Despite reporting rising revenues, profits and earnings per share for many years, net debt rose every year. The company had negative free cash flow for many years, and the share count doubled from 173m in 2000, to 341m in 2008.

Net profit margins and returns on equity, assets and capital employed all fell. This company stung me personally, because I failed to heed my own advice.

AJ Lucas

In more recent times, AJ Lucas Limited (ASX: AJL), has also fallen into difficulty and looking at a history of its financial statements, it’s not hard to see why. The share count has more than doubled from 32m shares in 2000 to over 76m shares currently. EBIT & profit margins have been very low in a number of years, offering no protection against any bumps the company might experience.

Debt has been at uncomfortably high levels since 2005, and combined with net losses, interest cover has been dangerously low. Shares in AJ Lucas are currently trading at $1.25, down from over $6 in 2008.

Neptune Marine

Neptune Marine Services Ltd (ASX: NMS) is another recent candidate. Since listing in 2004, Neptune has never reported positive free cash flow; the company has raised equity every year, and ended up with 74% of its net assets as intangibles. The company has also had to issue more equity – it now has 1.75b shares outstanding, and each share is currently worth about 3 cents; quite a fall from its highs of over $1.50 in 2005.

Billabong

Billabong International (ASX: BBG) is another classic example. Frequent “one-off” negative items as my colleague Scott Phillips mentions in this article. Billabong has exhibited falling return on equity, assets and capital employed ratios, falling margins, rising intangible assets (106% of net assets) and rising levels of debt. The company is now in a position where it is at the mercy of predators and its bankers and either needs to sell assets, raise debt and/or equity, (or all of the above), or accept an offer from one of the bidders.

The Foolish bottom line

Reported profits, revenues and earnings per share can misrepresent the real underlying performance of the company, so it pays to read company announcements and financial reports with a grain of salt. Here at The Motley Fool, we’ll try and guide you around these pitfalls.

Tomorrow, I’ll run through a few companies currently exhibiting these warning signs.

If you are looking for ASX investing ideas, look no further than “The Motley Fool’s Top Stock for 2012.” In this free report, Investment Analyst Dean Morel names his top pick for 2012…and beyond. Click here now to find out the name of this small but growing telecommunications company. But hurry – the report is free for only a limited period of time.

More reading

Motley Fool contributor Mike King doesn’t own shares in any of the companies mentioned. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Click here to be enlightened by The Motley Fool’s disclosure policy

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

asx share price competitions represented by businessmen arm wrestling
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

person reading news on mobile phone
⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »