During the week, Strawman member tomsmithidg kicked off a great discussion on “red flags”—those factors that can sometimes (but not always) urge caution for investors. A bunch of other members jumped in, fleshing out the conversation with an absolute goldmine of insights.
This is exactly the kind of no-nonsense, experience-driven discussion that makes our community so valuable. These aren’t just theoretical concerns—they’re battle-tested warning signs that investors have seen play out time and time again. Some are subtle, some are more obvious, but all deserve attention.
Let’s get into it.
🚨 Management Red Flags
🚩 1. Management Says One Thing, Then Does Another
It’s one thing to change your mind in response to new information. It’s another to outright contradict yourself within a short period. If a CEO confidently tells investors the company is fully funded, only to announce a capital raise the following week, that’s a serious trust issue.
Similarly, if management spends years telling investors a particular metric is the best indicator of success—only to suddenly shift the focus when performance declines—be wary. Companies that constantly move the goalposts are often covering up deeper problems.
🚩 2. Frequent Executive Turnover
The CFO has a front-row seat to everything happening in a business. If they’re bailing frequently, something’s up. But it’s not just CFOs—a revolving door of CEOs, COOs, or key operational leaders is also a red flag.
People like to be associated with success, and failure is always a turnoff. If executives keep walking away, it usually means trouble under the hood.
🚩 3. Dodgy Acquisitions and Empire Building
Some CEOs seem addicted to deal-making, expanding for the sake of growth rather than value creation. A bad acquisition can wreck an otherwise solid business—especially when it’s in an area the company has no experience in.
Watch out for:
- Debt-fueled acquisitions in unfamiliar industries.
- Little detail on how the acquisition will integrate.
- Management calling it “transformational”—often a sign they’re overhyping a poor decision.
- Fixed-price contracts in risky industries (like engineering or construction) that aren’t properly managed. (A lesson from RCR Tomlinson and Forge Group.)
🚩 4. CEOs Selling Big Chunks of Shares
Insiders sell for many reasons, but when a CEO offloads a massive stake, or is repeatedly selling, it’s worth paying attention. If management is genuinely optimistic about the company’s future, you’d expect them to hold (or even buy), not cash out.
🚩 5. Overly Generous Executive Incentives
The way management is rewarded matters. If a CEO is incentivised to grow revenue or profit at any cost—without focusing on per-share metrics like earnings per share (EPS) or total shareholder return (TSR)—it can lead to reckless decision-making.
Watch out for:
- Frequent changes in long-term incentive (LTI) plans without a clear reason.
- Metrics that encourage growth for growth’s sake rather than actual per-share value creation.
🚩 6. CEOs Who Treat Shareholders as ATMs
If a CEO sees shareholders as nothing more than a source of capital rather than true owners, it’s a problem. Signs include:
- Dismissing shareholder concerns in AGMs.
- Raising capital too frequently without clear returns.
- Overly defensive responses to reasonable questions.
🚩 7. Operational Failures Framed as “One-Off” Issues
Companies sometimes blame external events—supply chain disruptions, regulatory issues, or unexpected costs—for poor results. But if similar excuses appear quarter after quarter, it suggests operational weakness rather than bad luck. Look for companies that take accountability and show clear steps to improve execution.
📉 Financial Red Flags
🚩 8. Unusually Low Gross Margins
A company’s gross margin tells you a lot about its business model. Certain industries operate within predictable ranges—software tends to be high, while manufacturing is lower. If a company’s margins are significantly below what’s typical for its sector, something is off. It could mean:
- Hidden costs.
- Unprofitable contracts.
- A broken business model.
🚩 9. Structurally Poor Cash Conversion
Over time, a company’s cash flow should roughly track its net profit. If cash starts lagging profits, something’s off.
Common culprits include:
- Stretching receivables (delaying payments or aggressively booking revenue).
- Inflated work in progress (pulling future revenue forward).
- Heavy capitalisation of intangibles (turning routine expenses into assets).
🚩 10. A Spike in “Other Income”
Most companies generate small amounts of miscellaneous income, but a sudden jump in “other income” is a red flag. It often includes:
- Government grants.
- One-time subsidies.
- Accounting adjustments that artificially boost earnings.
- Reversal of contingent consideration (which often signals a failed acquisition).
🚩 11. Frequent “One-Off” Adjustments
A company taking a one-time impairment or restructuring charge isn’t necessarily a red flag. But when it happens again and again, it starts to look like a pattern of poor decision-making.
🚩 12. Companies Using Capital Raises or Debt to Fund Dividends
Some companies dilute shareholders or take on debt to fund generous dividends. A common excuse is that it helps distribute franking credits, but if dividends aren’t supported by actual earnings, that’s a major red flag.
🚩 13. Tax Discrepancies
A sharp but often-overlooked red flag: the difference between tax expense and actual cash tax paid.
A big gap might mean:
- Aggressive tax structuring.
- Unrecognized liabilities.
- A financial picture that’s rosier than reality.
🏭 Business Model & Industry-Specific Red Flags
🚩 14. Over-Reliance on a Single Customer
If a single client makes up a large chunk of a company’s revenue, that’s a huge risk. If that customer walks away or renegotiates terms, the business can collapse overnight. Even if the relationship is strong today, shifting budgets, competition, or economic downturns can quickly change the equation. A diversified customer base provides stability—without it, the company is at the mercy of forces beyond its control.
🚩 15. Frequent Renaming or Restructuring of Company Segments
If a company constantly changes how it reports its business divisions, it could be trying to obscure poor performance. Reshuffling segments can make declining units look better or hide losses within broader categories. Look for companies that maintain consistency in how they present their operations.
🚩 16. Company Pitches That Are Hard to Understan
If a business model or value proposition isn’t clear after a reasonable amount of research, it could be by design. Overcomplicated explanations can indicate a business model dependent on investor hype rather than real customer value.
🚩 17. Companies Exposed to Commodities with High Debt
Highly leveraged commodity companies have little control over their fate. When prices are high, debt looks manageable. But when the cycle turns, revenues can collapse overnight, forcing desperate cost cuts or capital raises.
The best operators stay lean and avoid excessive debt—because in commodities, survival depends on enduring the downturns.
🚩 18. Companies with Too Many Unrelated Divisions
Businesses that operate across vastly different industries often struggle with execution and synergies. The more unrelated, the bigger the risk—each segment may require unique expertise, supply chains, and sales strategies that don’t translate well across divisions. Instead of diversification reducing risk, it can spread management too thin, leading to inefficiencies, poor capital allocation, and underperformance across the board.
🚩 19. Related Party Transactions
If a company is renting office space from a director’s private business or paying millions in consulting fees to a related party, that’s a red flag. It’s not illegal, but it reveals a lack of independence and alignment with shareholders. When executives steer company funds into their own pockets (or those of close associates), it raises questions about priorities—are they focused on growing the business, or enriching themselves?
🚩 20. Lack of Transparency in Products or Operations
If a company refuses to demonstrate its product or upload a demo, that’s a major red flag. In an era where videos, live demos, and customer testimonials are easily accessible, there’s little excuse for secrecy.
A lack of transparency often signals deeper issues—either the product doesn’t work as claimed, isn’t market-ready, or lacks real competitive advantages.
🚩 21. Brokers With Large Vested Interests
Be cautious of investment reports that seem overly optimistic—especially if the firm behind them has a financial interest in the company. Brokerages, analysts, and investment banks often have hidden incentives, whether it’s securing deals, underwriting capital raises, or maintaining corporate relationships. A glowing report doesn’t always mean a great business—it might just mean someone stands to profit from your enthusiasm.
Final Thought: Trust, But Verify
Not every red flag means “sell,” but a pattern of them should set off alarms. Some issues have valid explanations, while others signal deeper trouble. The trick is spotting when caution turns into conviction.
Investing is a game of probabilities—your job is to stack the odds in your favor. Stay curious, question everything, and never let attachment cloud your judgment.
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