When you are investing there are rules and the number one is try not to lose money. The second rule is remember rule one. However, that rule is often broken for a variety of reasons because we all want more. Sometimes we want more, but did not do our homework, but we still want more.

In a book called The Signs Were There by Tim Steer, published by Profile Books, London, UK, 2019, the author is a Chartered Accountant who became an investment analyst and is presently a fund manager for Artemis. Mr. Steer is based in the UK, but accounting rules apply to all western countries including the US.

Most people invest in the biggest companies and for the most part they are going to do okay by rule number one. As a fund manager, Mr. Steer is exposed to a great many companies because he has money to invest and needs to constantly do research and analysis to try not to lose money.

Mr. Steer offers the following signs from the annual report of companies. If you see these signs while doing your homework, look for alternatives.

a deteriorating current asset quality, where there is an increase in the subjectivity in valuing them. Amounts recoverable on contracts which may take ages to collect are lower quality current assets, when compared to cash and invoiced receivables that should be easily to collect.

large and increasing accruals of revenue where chosen accounting policies allow for the recognition of revenue ahead of the cash actually being collected. (when is a sale revenue?) when the contract is signed, when money comes in, some companies stretched the limit)

large and seemingly unsubstantiated goodwill amounts in the balance sheet

relying on acquisitions to keep profits moving ahead. (one company had 37 acquisitions in 6 years, do you really believe they found cost savings and synergies?)

disclosed related party transactions. Run away from any company that does business with related parties. (related parties tend to do real estate deals and the price always goes up).

reported worrying trends in its performance. A deteriorating set of numbers over time showing rising stock levels, poor cash flow, falling margins or big increases in working capital can be a trend that is your friend, telling you to avoid the shares. (an example was a pet food company, the big margins were made changing habits from wet (10%) to dry (50%) pet food, which the private equity folks did. when the company became public where were the fat margins?)

growing levels of stock or makes odd adjustments to its stock valuation. (companies can issue stock at what valuation?)

capitalized large costs that under normal circumstances would be expected to pass through the income statement.

being too optimistic as to the recoverability of its debts and failed to provide adequately for bad ones. (it is easy to lend money, it is harder to collect it)

Linking to dividend paying stocks, if you invest in companies that make profits, and you understand how they make profits that can pay dividends the odds are you will not lose money. However, since you are human you will likely have some investments that you were intending to have short term holdings, but they became long-term holdings because the price went down. For the money not in dividend paying stocks, they take longer to do your homework because making profits consistently is a hard task to do. For those companies you have to watch out for the warning signs.

There are more questions than answers, till the next time – to raising questions.