As an investor you need to know the reason for decline in share prices in the stock market. In this article, we will help you understand when a stock can decline and why you should get out of it.
Earning slow down
Earnings are considered as the oxygen of a company.
Company’s financial health depends on how profitable it is. If it’s showing good profit year after year, then it’s in good financial health considering other fundamental factors are on track.
If the company is not generating enough profit, then slowly the financial health will deteriorate as it wants outside capital to be in the market. Outside capital can be in the form of debt and/or equity. But if nothing works out, then the capital introduced into the company will also finish.
Investors and/or lenders will also not be taking interest if the company is not showing any sign of future profit.
Better to avoid these kinds of stocks.
If you are putting your money in a loss making company without knowing its fundamentals, then you are not investing, you are speculating.
Slow down in Sales
If sales and earnings are strong and rising, then the company is a good bet for investing.
In case the company’s sales are not moving up, then it’s better to work with caution. If it’s due to a temporary issue like the overall economy is not doing well, then it’s fine you can compare with industry peers to know how the stock has performed.
If the company’s sales are going down when for others it’s going up, then find out the reason for it. You need to read management guidance to understand what exactly has happened with the company.
Sales can go down for following reasons;
- Marketing issues
- Competitor is more aggressive
- New products are introduced by competitors
You need to find the real reason why sales are decreasing.
Debt is too high
Debt is one of the key funding sources to invest for better infrastructure. However, excess debt is a red flag on the company’s financial condition.
Certain types of companies are high on debt based on their industry and investment. You need to look at the company’s earnings to find out whether or not it can cover the cost of debt.
If the company can’t cover the cost of debt, then it’s not a candidate for investment for the long run.
Experts call high debt struggling companies the kiss of death.
Dividends are the primary reasons for conservative investors to hold income stocks. If a dividend paying stock pays less in comparison to the expected amount, then many investors will prefer to move to some other dividend paying stock.
Does it mean that you will be selling the stock. Wait, try to find out why the company has declared less dividend. Maybe the company wants to reinvest more funds in order to expand or to cut down debts. You need to check its earning first, if it’s down and in future it wont go up, then you might go for selling the stock.
However,if your investment is purely based on income stock, not having the growth in mind, then try to move to some other better dividend paying stocks.
Insider selling and Rumors
When you see insiders are selling stocks of the company, consider it as a red flag.
Insiders are the company’s key management personnel such as president, vice president, CFO, COO etc.
You might have heard the proverb “buy the rumor, sell the news”. In practice this is the tendency of most of the traders. They push up the stock prices on rumors or when the expectation is high and then sell once that news has been released, even if the outcome is positive for the company. In which type of scenario you will find the company’s share prices decline with good news.
Economic downturn and Industry issues
When an industry problem arises due to an economic downturn or any political or government decision, then no matter how good the company is, it will have an impact on its top and bottom line.
Even problems in one industry might affect the other industry. You need to keep yourself updated with industry related data to find out when and how its going to impact your stock.
For example, any impact on auto sales will have a negative impact on auto ancillary companies.
Similarly, if the finance sector is not doing well and people are not taking loans in order to buy cars or homes due to rise in interest rates, then the problem with the banking and financial sector might affect the auto sector and real-estate sector.
Political decisions always have an impact on the stock market. You need to find out companies and sectors that can be in government radar.
Assess the situation, ideology of the political party and the leader before investing. If the political party and its government is better for development, then you might consider those sectors where they will invest money.
You can have a close watch on your country’s budget, statement of the finance minister and prime minister to sense what is cooking.
If you found a stock which is in the target of government action, then avoid it.
Some stocks are not bound to political problems, you might consider buying those. Do your own research before buying those stocks, don’t trust any analyst for that.
One of the key factors we take into consideration is a company’s financial statements.
Many times we have seen company’s key management personnel are in the practice of cooking books. If such things are happening and you are on the basis of accounting figures, taking your investing decision, you are almost finished.
Therefore, you need to be with the management who are trustworthy. They don’t practice unethical things.
I know it will be difficult to find out what the management is up to. But, at least you can avoid bad management by looking at their past history.
Best example where management has spoiled the entire company and investor’s money are;
Major shareholders selling
One of the most important criteria to understand a stock is to steady it’s shareholding pattern. You will understand the percentage of holding of each shareholder.
Stocks can be held by institutional investors, fund managers, insurance companies and other large players. If these shareholders decide to sell their stocks at a given prices or after a particular event transpires, share prices has to decline. You can get these details from stock exchange data available at their sites.
If the fundamentals are intact, the stock prices will jump back again. If there are issues with fundamentals, then it can further go down. As an investor, you have to find out the real reason for such selling and the fundamentals of the company.
Not meeting market expectation
Market expectation or whisper number is an unofficial estimation of a company’s top and bottom line circulating in the market. Often companies fail to meet or beat market expectations. As a result the stock prices will decline.
Sometimes the company’s operating margin fell dramatically in comparison to last quarter or its cash position dwindled due to certain factors.
There can be some other factor which can have an impact on the top and bottom line of the company.
Investors carefully review these details and try to find out whether or not the company beat earning estimates. You can also attend an investor’s conference call conducted by companies after earnings are released to know how the company has performed.
If investors find any major area of concern affecting companies top and bottom line or the earnings report does not meet street expectation, the stock’s prices will usually decline due to less demand and high supply.
As an investor you need to play the role of a detective to find out the real reason for stock prices decline. If you are buying stocks for the long term, it’s important for you to always revisit your investment thesis with new announcements and developments.
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