The collapse of the construction firm Carillion will obviously have immense implications for their workforce, their customer base and, given the level of public sector involvement, for the community as a whole.  However, there is another sector that will suffer and that is the investors.

Clearly investment in listed securities is to some extent a gamble (albeit an informed one) and it may be that you don’t have as much sympathy with those who have lost out on share values as you do with those who have lost their jobs or the benefit of what Carillion was to build for them. (But don’t forget that the losers will also be the institutional investors, such as pension funds and savings and investment providers!).

Could investors have spotted early warning signs? By definition, unless you know a lot about the construction sector, these signs would be financial in nature, that is, derived from Carillion’s published accounts and financial statements. So is it possible to see signs of a less than robust financial state of affairs – and what are the key factors?  These are some of the things you should look out for:

  • Acquisitions when coupled with excess debt and a pension deficit  
  • Narrow profit margins
  • Revenue streams from volatile sources
  • Excessive and unexplained swings in cashflow

There may be perfectly rational explanations for any of these factors (and this is what you should look for). But where you see repeated or multiple instances then maybe it’s time to beware.

And here’s the thing – the very same key factors that should urge caution in investing can also be danger signs in your own business. It’s tempting to feel that where the numbers are small, the effect cannot possibly be significant, and this may well hold good in the short term.  But over a longer period, unless things change, what began as say an overall downturn in an already narrow profit margin may turn into a downward spiral, especially if combined with one or more of the other key factors.

With your own business, you can at least take steps to redress the balance. But to return to investing in listed securities, are there any other indicators to look out for?  One that springs to mind is the Price/Earnings ratio, which you’ll see published in the financial press or on financial websites. At its simplest, the P/E ratio represents the measure of confidence that the market has in the company, and it’s a common measure of valuation.  Fine – clearly, you’re going to invest only in shares where the P/E ratio is robust. But what if those same shares are showing a high yield? Wouldn’t you be tempted to invest? Well, maybe you’re happy to back your own instinct over the market pundits – but a low P/E ratio could be the market’s way of indicating that it doesn’t believe that the promise of ongoing profits will hold good.

Please do share any experiences of investing, or indeed any ways in which you’ve used the key factors to make a business decision.