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3 ways to spot a failing business

Economic growth, Financial Events, Leverage, Oil markets
By Paul Hodges on 02-Mar-2008

Anthony Bolton of Fidelity has been the UK’s premier stock picker for 30 years. His learnings from his ‘worst disasters’ provide an insider’s perspective on how to spot a company that’s about to fail. He revealed his top 3 warning signs in the Financial Times this weekend:• Weak balance sheet. Bolton’s major focus is on high debt levels. In good times, this magnifies returns for the owners and makes ordinary managers look like geniuses. But in downturns, bankruptcy can occur very quickly, as the company can’t meet its interest payments and simply runs out of cash.
• Poor business model. This is particularly relevant when external circumstances change. For example, when oil prices were low, being close to the customer meant margins had plenty of scope to increase. But with high oil prices, some companies can get squeezed between a rock and hard place – feedstock prices increase, but can’t be passed through.
• Poor management. More difficult to spot from the outside, but sales people and business managers can still form a view on the competence and honesty of the people with whom they deal. A good tactic is also to solicit views from a variety of people in the industry. Who do they admire, and who makes them nervous?

Bolton’s conclusion is very powerful. He comments that ‘I am always surprised by how little analysis of balance sheets is done by most analysts’. ‘Often’, he adds, ‘I will read a report on a company that I know has a weak balance sheet, and no reference will be made to it at all.’