10 Signs a Stock Is About to Tank

By Tim Lemke on 9 July 2015 0 comments

If we all knew exactly when stock prices will go up (or down), we'd be residing on our own tropical islands. But predicting the markets is a tough business. That said, it's often possible to know that a stock is due for a big drop in value. There are a variety of signs that can help us know when a company may be overvalued by the stock market.

Note that even if one or more of these indicators applies to a stock in your portfolio, it doesn't necessarily mean you should sell. In fact, it may be a good time to buy more of a stock, if you believe it will eventually rebound.

Here are 10 potential signs that a stock you own may be ready to tank.

1. The Price-to-Earnings Ratio Is High

A stock price should be based at least loosely on its earnings, so it's important to track a company's earnings on a per-share basis. If a stock is trading at $40, and it earned $2 per share, its P/E ratio is 20. Generally speaking, any P/E ratio over 25 is considered too high, though it's also important to look at expected growth rates. If a P/E ratio is high and a company does not appear to be projecting strong future growth, the stock may be ripe for a tumble.

2. An Earnings Announcement Is Delayed

Companies are required to announce their earnings each quarter, but can occasionally delay their release for a variety of reasons. Often, it's a sign that there will be a some surprise negative news, or some other problem. It's not necessarily wise to immediately sell a stock if the company is late making an announcement — you should at least hear the company's reasons and determine if they are valid — but it can be a foreshadowing of bad news. Researchers from Harvard noted that news of an earnings delay can cause the price of shares to drop 6% in a single day.

3. Price Is Sinking, But Volume Is High

When trying to determine whether a stock is ripe for a big fall, it helps to look at the volume of activity. Generally speaking, the worst combination for a stock is to see higher-than-usual volume on a stock coupled with a lower share price. If you see these two things happen, it's often an indicator that a lot of shareholders are selling. If you're into technical analysis of stocks, this is often referred to as the "accumulation/distribution" indicator.

4. Shares Are Trading Well Above Consensus Price Estimates

Stock analysts are known to issue estimates of a company's earnings per share in advance of an earnings report. And there is something known as a "consensus estimate" that combines the opinions of the analysts and determines a target share price. When share prices are well above the consensus estimate, it's a sign that the company may be overvalued. Be wary of any company that is trading at more than 25% more than the consensus estimate.

5. The Advance/Decline Line Is Sinking

This is another technical analysis tool that can be used to predict when an upward trend may be coming to an end. It's particularly helpful in determining the future path of the overall market, so it can be used to predict prices for things like S&P 500 indexes or ETFs. In simple terms, the advance/decline index tracks the difference between the number of stocks on the rise versus the number on the decline. If the market is going up, but the number of declining stocks outweighs those on the rise, then a reversal of the upward trend may be on the way.

6. The Competition Shows Up

It happens all the time. A company has an innovative and popular product, and spends a few years raking in the dough. But then a much larger company unveils a similar product and has the muscle to dominate the space. Game over. We saw it with Blackberry, after Apple introduced the iPhone. More recently, we've seen struggles from camera maker GoPro, after Sony, Garmin, and others announced they would produce an action camera.

7. Inventories Are Rising, But Not Sales

If you have a company with a rising inventory of products, that can be a good thing, as it may indicate they are stocking up to anticipate demand. But you have to convert inventory into sales. One key thing to track, if you are willing to dissect an earnings report, is a company's inventory-to-sale ratio. The right ratio depends on the industry, but it's generally good to see a ratio close to 2:1. The Census Bureau tracks these ratios for various industries, so check out the historic ratios to see if a company is out of line. If it seems like a company has a lot of inventory it's not selling, the stock price will suffer.

8. There's Been Bad News

An airline stock right after a deadly plane crash. An automaker after a massive recall. A drug company after a rejection by the Food and Drug Administration. Every company could be subjected to a potential single event that will hammer its stock price. Be careful, though, before unloading a stock in this situation. A major negative event might lead a stock price to tumble, but it doesn't necessarily mean that the company's fundamentals are unsound.

9. Economic Indicators Aren't Good

It's possible to predict how some company share prices will perform based on statistics that reflect the overall economy. The unemployment rate and consumer confidence survey can be indicators that affect retailers, for instance. Not all companies are impacted by the broader economy in the same way, but some are uniquely sensitive to these reports. And a bad report could mean a drop in share prices.

10. A Leadership Change Is Rumored (Sometimes)

Shareholders like to see stability at the top, and a potential change in leadership can make investors nervous, especially when the top executive is a hugely influential figure. Consider what happened to Apple after Steve Jobs passed away, when shares fell about 8% in a few days. (They did rebound.) A well-run company will have a good succession plan in place, so a leadership change is not always a major problem. And sometimes a change will be for the better. Just be aware of a company's reasoning behind the change, and understand that share prices may be impacted for a brief period while a leadership change takes place.

What stock value indicators do you track?

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