Ten tips to spotting trouble in companies you cover

By Cassie McLean

Learning the implications of a just a few corporate decisions may be all it takes to foresee distress within a struggling company, said Mark Tatge, former senior editor at Forbes magazine and a distinguished visiting professor at DePauw University.

Tatge spoke at Saturday’s Society of American Business Business Editors and Writers‘ conference in Indianapolis, detailing a concise list of 10 red flags that should cause all privy business reporters suspicion.

1.   Deferring expenses: Companies are supposed to match income with corresponding expenses. Reporters should expect that in the period where the revenue is recorded, the expense to create that revenue should also be recorded. The effect of amortization over time means the current company’s profits will be inflated.
2.   Pro-forma earnings: Companies that plan to merge or divest often come up with “pro-forma” earnings, an estimate of what the firm will be after the merger. However, the number is often based on inaccurate assumptions. For example, management may include or remove net income that it feels is not “material” to the remaining company.
3.   Firing auditors: Often this occurs due to a disagreement over accounting standards and the discrepancy can clue reporters into bigger issues.
4.   Burying exhibits: Companies often bury important documents through several levels of reports dating back numerous quarters, or worse, years. To find such items, reporters may have dig through many levels of 8Ks.
5.   Fudging inventory: Keep an eye on how companies report the value of inventory, found on the balance sheet, either through FIFO (First In-First Out) or LIFO (Last In-First Out). Companies are required to pick a method and should not switch. Doing so, particularly switching to FIFO in times of rising costs, can produce higher profits.
6.   Stock buybacks: Beware. While the immediate impression is that the company is confident in its future prospects, a good reporter must ultimately ask, “Should they be doing something different with their cash?” Additionally, buyback artificially improves earnings per share.
7.   Shell games: Companies are forced to set aside funds to cover defaults, decreases in asset values or inventory obsolescence. This pot of money, called asset reserve, is expensed and reduces net income. Thus, if a company has set aside too much, it can recapture reserves, boosting profits and lessening expenses for a given quarter.
8.   Pay attention to cash: Look at how much they’re generating versus spending and whether the company has enough to cover current liabilities. Subtract current liabilities from current assets to find out the company’s working capital, how much in liquid assets the company has to pay its debts in the future.
9.   Understanding liabilities: Companies will understate liabilities to inflate current earnings. Look for costly contracts or contingencies, like merger breakup fees, pending lawsuits or contractual arrangements with vendors.
10.   Blowing deadlines: If a company misses a 10Q or 10K filing, it’s an immediate red flag. Suspect bankruptcy or liquidation, a large charge against earnings, re-valuation of assets or the business itself, or restatement of past financial results.

The challenge, however, is that no one item will get you further than another.

Often, Tatge said, it’s about being a careful reader of financial statements, drawing comparisons and remembering the hackneyed idiom: If it looks too good to be true—it probably is.

McLean is a UNC-Chapel Hill journalism student attending the SABEW conference.

Chris Roush

Chris Roush was the dean of the School of Communications at Quinnipiac University in Hamden, Connecticut. He was previously Walter E. Hussman Sr. Distinguished Professor in business journalism at UNC-Chapel Hill. He is a former business journalist for Bloomberg News, Businessweek, The Atlanta Journal-Constitution, The Tampa Tribune and the Sarasota Herald-Tribune. He is the author of the leading business reporting textbook "Show me the Money: Writing Business and Economics Stories for Mass Communication" and "Thinking Things Over," a biography of former Wall Street Journal editor Vermont Royster.

Next NYT biz editor may be headed for London, but nothing imminent »

Previous « Six voted to SABEW board

View Comments

Nik Litwin says:
March 22, 2012 at 3:58 am
I would add profit warnings. Some think they are a sign that the slate is clean and the bad news is out. I've no actual data on it, but I see when one warning comes there's often another one or two that follow. Would make an interesting piece of analysis.
Also - when it comes to buybacks, one should also understand when it's a sign that they have no organic growth opportunities. That's not always bad, but context is important.