Lesson 5 of 5 · 4 min · Reports

Five warning signs

Patterns in the three statements that should make you look closer.

1. One: profit keeps rising, but cash from operations does not. You met this in the last lesson. It is the most important warning sign of all, because cash is hard to fake.

2. Two: money owed by customers grows much faster than sales. Say sales rise 10% but receivables rise 40%. The company may be booking sales before it gets paid, or offering easy terms to hit its numbers.

3. Three: stock piling up. If inventory grows much faster than sales, goods are not selling as planned. Discounts or write-downs often follow.

4. Four: "one time" costs every year. Companies often show an adjusted profit that leaves some costs out. The official numbers must be shown too. If the one offs never stop, they are simply costs.

5. Five: the share count creeps up. Paying staff in shares is a real cost even when no cash leaves. If the number of shares rises every year, your slice shrinks, as in the lesson on dilution.

6. None of these proves fraud. Each has innocent reasons too. They are signs to read the notes, compare with past years and rivals, and ask a question before you buy.