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Danger Signs for Stock Market Favorites

1 September 2006 - Features - Editor

Every stock market has its favorites. These are member companies with transparent governance, dream increases in profits quarter after quarter. They are referred to as blue chips or gilt edged assets, and form the backbones of myriad portfolios.

However history teaches the stock market community that times change. New kids appear on the block, and the best companies begin to run out of steam. The cycles change from sector to sector, and there seems to be no reliable way of knowing as to when it is opportune to exit from ownership of today's hero companies. Here are 5 hot tips:

  • Shaved margins: these must raise red flags for stock market investors, especially if a company is not able to match its direct competitors in recovering cost increases from the wallets of its customers. Revenue growth ahead of profit increases should also worry stock market investors, for they show a misplaced pre-occupation with market share.

  • Fixed cost growth: an expensive advertising campaign to build a brand is excusable, for it can be turned off at will. A disproportionate rise in the wage bill is another matter, especially in industries and territories with organized labor, for it means that the cost structure is disturbed on a semi-permanent basis. Stock market investors should keep special tabs on companies which hand out expensive handshakes in order to prune headcounts, lest they go on recruiting sprees shortly thereafter!

  • Internal Marketing Failures: companies which deliver less to customers than they promise are in danger of extinction. Complacency is a major risk for large corporations with entrenched brands and low competition, for they tend to become immune to changes in competition and consumer expectations.

  • Distraction: litigation and hostile take over bids sap energy and enthusiasm of management teams at least, and may cause a dangerous shift of focus from market competition to corporate egos and survival issues. A company that spends much time in defense in the public space probably does so at the cost of your stock appreciation and investment return interests!

  • Ambitious investments: optimistic projections that cause massive expansions in green field areas may work out as planned, but it does not always happen that way! A company that uses modest success to plan aggressive expansion or wild diversification can put your investments at unacceptable risk!

Take a look at the stars in your portfolio, and examine critical profit drivers with a doubting microscope. You may well find opportunities to book glorious profits and plough them in some more sober furrows!

 


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