Here's a quick couple off the top of my head @tomsmithidg

• CEOs and MDs being incentivised through remuneration (LTIs/STIs) to grow revenue or profits rather than incentives based on EPS or TSR. Particularly when those execs then engage in bad M&A to achieve those low hurdles by simply making the company bigger instead of better;
• Another orange flag is a when company management say one thing and then do another, such as saying they don't need to raise capital, and then raising capital the following week;
• Reporting metrics being changed to suit whatever makes the company look best, one example being the CEO/MD telling analysts, brokers and shareholders / investors for years to watch the occupancy numbers in his childcare centre business because as long as they were high, like 90% or better, they would make good profits regardless of everything else, then suddenly when that metric declined the story changes and now we should all apparently focus on something else which is a far better indicator of the health of the business. Yes, that was ABC Learning, who went broke, giving shareholders a 100% loss and sending Eddy Groves into personal bankruptcy, from which he has since emerged. Another thing Fast Eddy did at ABC Learning in the early days was explain how he always paid a low multiple for private businesses and then they usually almost doubled in value when they were rolled into ABC, a public company that was valued much more highly by the market than those much smaller private companies had been. That was a nice accounting trick to create value out of thin air, however it begun unravelling when Eddy ran out of Childcare Centres to buy at those low multiples which was party due to competition from other roll-up plays (one of them also an ASX-listed company) as well as the acquisitions needing to become larger and larger as ABC grew its own market cap, just to move the dial. He started paying higher multiples because the whole thing depended on M&A, as roll-ups usually do. When the M&A music stops, it all falls apart, particularly when there's bugger-all organic growth and you've got a mountain of debt to service. Basically what I'm saying here is that you want management to always sing from the same hymn sheet, not change their tune regularly. Beware of departures from what had previously been considered to be givens, i.e. established procedures and metrics that had worked for years;
• When the company starts losing a significant number of key executives who leave suddenly and without explanation, particularly CFOs and it's even worse when those CFOs haven't been there long. When a company goes through 3 or more CFOs in 5 years, that's a RED flag.
• When an MD or CEO sells down a significant portion of their shareholding in a company, such as $20m worth of shares, and says it's to pay tax or something equally rediculous. OK, if it's Richard White or somebody like that, yes, THEY might have a $20m tax bill, but most CEOs and MDs do not, and so if they're selling down, like 40% or more of their shares in the company without a plausable explanation, that's an orange flag for me. If it's simply for diversification purposes, to not have all of their eggs in one basket, that can be plausable, but it still signals that they see the current levels as suitable to take profits (possibly they think the company is either fully valued or overvalued), and that they also possibly see other opportunities out there that might provide a better return with that money;
• Something I have only become pissed off about in recent years is companies who do a CR or borrow money to fund generous dividends. Some will use the excuse that it is to distribute excess franking credits, which are of course zero use to the company but may be of use to many of their shareholders, however if they're diluting their shareholders to pay for the divs or paying interest on debt used to fund the divs, that's certainly an orange flag; and
• Any company who has the vast majority of their revenue and therefore profits linked to a single customer or client, or even to just 2 or 3 big customers. Jumbo (JIN) was in this position years back however they have diversified their revenue since then. We have seen telcos go pear-shaped because of companies like Telstra not renewing agreements, and in the past week we have seen BSA crash and burn after the nbn declined to award them another contract to replace the one that is running off this year. There are loads of other examples. I call it concentration of revenue risk. Some people get worried when companies rely on just one sector for their revenue. Fair enough. But it's significantly WORSE when they're mostly relying on a single company within a single sector for the majority of their revenue.

I'll add some more later.

Orange flag. CEO's who treat shareholders as generators of equity, not as owners. It must be incredibly difficult running a successful company and getting 2nd guessed by a random shareholder who owns a comparatively tiny amount. But if you can't at least pretend to respect the Shareholder>Board>CEO flow down it doesn't sit right. I sat through one AGM last year where the CEO and CFO seemed like they didn't want to be there and seemed almost annoyed that they had to justify themselves. I was already 50/50 from a quality/valuation point of view but it was enough to give me the ick and sell. I felt like if gave me a window into some of the unquantifiables.

Here one - companies who are exposed to commodities and have taken on a LOT of debt and then the commodities they are exposed to fall in price and the outlook looks murky, i.e. one or more of those commodities may well be trading at even lower prices for a while. And that's without any haul road issues.

Here's another - companies who get a new MD/CEO who decides to sell off part of the business (one or more business divisions) that have been operating successfully for years and take the business in a whole new direction, particularly where that CEO/MD has little to no experience in that whole new direction. Example - solar farms (RCR Tomlinson/RCR Engineering).

In a similar vein, when a company makes an acquisition that they say is complimentary to their existing business but is in a niche area that they have zero prior experience in and the acquisition terms are not well structured - like all or most of the cash is paid upfront and there are bugger-all earn-out clauses that would incentivise the management of the target company to hang around and make sure the thing earns the profits they say it will. So the prior management of the target company move on (leave), the acquirer goes into this new area hammer and tongs, undercutting everybody else to carve out maket share and signs big fixed price contracts for projects they ultimately fail to deliver either on time or on budget. Example - power stations - Forge Group (was FGE).

The lesson from those two examples is that you want a company to usually stick to their knitting, i.e. know what they do well, and stick to what they know, and if they do want to expand either geographically or into new business segments, that they do it steadily and carefully and manage risk really well - positive examples of companies who excel at this are ARB Corporation (ARB), Lycopodium (LYL) and I believe Nick Scali Furniture (NCK) is now proving to be another one with their slow and steady expansion into the UK, which had been flagged for many years, but they waited for the right opportunity to do it with the least amount of risk (including the least amount of up-front capital).

A second lesson is that we should, as a general rule, be very careful with companies that tend to use fixed price contracts in areas like engineering and construction, unless they are very, very good at what they do, and have been doing it a long time and have their risk management procedures really up to scratch. An example of a company who gets this right is GR Engineering Services (GNG), and there are countless corpses of companies who have got it wrong, including both RCR and Forge Group.

I hold GNG, ARB and LYL, not currently holding NCK, but I often do. RCR and FGE went broke, and I did hold shares in both, but I got out before the final trading halt with both of them. I wasn't so lucky with Babcock and Brown, but that was a GFC story, and it's probably not as relevant these days.

@Bear77 Awesome mate. I really hate the CR coming after they deny needing one too.

I know Eddy Groves was targeted hard by shorters when it became known how highly leveraged he was when he tried to expand into the US, but the low multiple creating value from the ether is interesting and reminiscent of the Euro when they rolled a whole bunch of low value currencies (like the Lira and the Drachma) and made a currency worth more than the US dollar.

Thanks for replying, cheers.

No worries @tomsmithidg - good topic - thanks for starting the thread. Yeah that Eddy Groves story about changing key metrics was told to us by Geoff Wilson at one of WAM's roadshows a while back (before Covid), and is also relayed by Matthew Kidman in his book Bulls, Bears and a Croupier: The insider's guide to profiting from the Australian stockmarket which is a good read. Matthew Kidman was Geoff's first employee at Wilson Asset Management, or the first portfolio manager Geoff hired anyway, back in the day - Kidman had been a financial journo prior to that. WAM is a lot bigger these days and Kidman runs his own fund, Centenial AM, however the lesson still stands the test of time, beware the change of tune.

Hey @Bear77 , what about when a milkman tries to run a child care business?

The part that irked me the most about the ABC Learning downfall was the brokers espousing the BUY signal (Bell Potter predominantly) only a matter of weeks before they went belly up.

So maybe my Orange Flag from this is Brokers with a large vested interest.....beware!!

My orange flag, which sometimes/often turns red - companies with multiple divisions selling/producing completely - or only tangentially connected - products. Might be in the same industry segment, but the point is that the products are sufficiently different that there is little cross-over with technical expertise, manufacture and sales force. MIN as was comes to mind - until recently, they had 4 divisions: crushers, iron ore mining, lithium mining - all of which you could make a case were connected, but actually need different sales forces. And then gas. I tripped over the gas and stopped and went no further. For which I am thankful.

Some great answers so far, a couple from me focused more on the business rather than management (though I do agree when it comes to red flags management deserve the most scrutiny):

• Unusually low gross margin. You can generally look across a peer group or broader industry to get a feel what a normal gross margin should look like. Software 80-90%, retailers 50-60%, engineering/construction 20-30%, etc. Of course they can move around based on individual businesses but if they aren't close to those rough rules of thumb it is worth digging deeper. As an example, I was always sceptical of EVS's ARR because their gross margin of 50% is well below what you would expect from a software business, suggesting they were likely bundling low margin hardware revenue into ARR.
• Structurally poor cash conversion. Cash can bounce around for all businesses but over time it should roughly track NPAT assuming re-investment is roughly in line with D&A. If cash starts to lag NPAT for a few periods in a row it is important to work through the balance sheet to see where it is getting stuck. Common culprits: receivables/payables getting stretched out, increasing work in progress bringing forward revenue to the balance sheet, increasing capitalisation of intangibles ahead of historical D&A.
• This one is a bit trickier because tax is a complicated beast, but it is worth checking the difference between tax expense recorded in the P&L and the actual cash tax paid. There can be many reasons for discrepancies but if there is a big gap always worth a quick question to the CFO, it can be a great question to test their knowledge of the business.
• A spike in "other income". Most companies generate a few hundred thousand in sundry income, but if you see a big jump it is always worth taking a look because generally it will be a grant/subsidy or accounting entry that falls through to EBIT at 100% margin. Reversal of contingent consideration is always a great one to watch for, because it also signals an acquisition is underperforming previously set expectations if the company has already booked a contingency for an earn out payment.

I'll try and think of some others today but love the thought exercise!

A great little thread here. Here are a few of my orange/yellow flags:

• Constant "once-off" adjustments to preferred metrics that don’t persist year to year. This suggests a management team focused on keeping up external appearances.
• Frequent renaming or restructuring of company segments. Again most likely they're optimising for appearance rather than anything functional underneath.
• Operational mistakes that lead to "one-off" negative impacts. In my experience, if a company struggles with basic execution, there’s often a deeper issue that leads to more mistakes over time.
• Company pitches that I don't understand or understand why it matters. If I can't understand a company fairly quickly, it's usually because there's a lack of a strong customer value proposition.

That said, no company is perfect, and no CEO is a Warren Buffett when it comes to capital allocation. A big part of investing is to be able to adjust to each individual situation and recognise which flags are deal breakers and which ones deserve some leeway.

Yellow flag when a company's announcements scream EBITDA and I have to go searching for NPBT or NPAT.

Orange flag when everything is "normalised", which too often makes the numbers very un-normal. With a wave of their hand they wash away share-based payments (voila, a free way to pay staff), acquisition costs (if growth through acquisitions is part of the strategy, then the acquisition costs are part of doing business), technology upgrades (because that only happens once, right?), "one-off expenses" (a bit like the one-in-a-century disasters that happens somewhere once a year).

Some good ones on here. I'll add a few

Related party transactions: This is an issue that pops up in small/micros quite a bit where the company is renting offices off a major shareholder or there is consulting work being done by the major shareholder's company. Seems to pop up a bit in the junior resource space, but that's not somewhere I spend much time.

Changes in LTI's: LTI hurdles are almost always set low enough that they are a reasonably soft target for management to hit. When those targets change and there's no rhyme or reason then it's often a good indicator that the economics of the business are changing.

There's often just a vibe to these things. You read the accounts and then you hear management speak or look at the presentations and its hard to square what they are saying with what the accounts say. A lot of the time they will be managers who are empire builders and spend too much time thinking about the blue sky and not enough on the day to day. Apologies to any salespeople, but I find CEO's from a sales background often have that mindset.

@UlladullaDave Regarding related party transactions. That's cropped up recently in two majors - MIN and Chemist Warehouse/Sigma. With MIN, it's been going on since it listed, primarily driven by CE and his merry band of close-friend execs and directors, and appears to be still ongoing to some degree. With Chemist Warehouse, it seems it's an entrenched feature of the way the company's been built, involving the original owners via several ongoing deals. Liable to be messy going forward.

Not seeing a product in action or refusal to upload a demo has to be one of my frustrations.

We now have tools to record and capture using Zoom, Microsoft Teams and even Powerpoint. Plus we have transcribers that can translate audio

There is no excuse now. Go and upload that video of your brilliant product that will take over the market.

And sell it like there is no tomorrow.

Or get a user review posted on Gartner.

Hansen's Powercloud. has to be a good example of this