Education

Easily avoid disasters

Easily avoid disasters. Lessons from the Australian share market


Lincoln’s world-leading methodology has predicted 95% of corporate failures in Australia, well before they happened.

In this article, Lincoln Indicators discusses:

  • A reminder of ASX’s biggest corporate failures, and the consequences for shareholders.
  • De-mystfying the belief that companies are ‘too big to fail’
  • Why manageable levels of debt, profits and cash flow are the kings when investing in shares.

The bigger they are, the harder they fall. We’ve all heard that saying, and it certainly has added meaning when applied to the Australian share market.

Over the years, many investors on the Australian Securities Exchange (ASX) have experienced the financial pain of a corporate failure, having first watched the value of their shareholdings plummet, and then totally disintegrate, in front of their eyes. Having invested in big, supposedly safe companies that had promised them the world, these company shareholders suddenly found themselves caught in a financial storm, with no hope of recouping their investment.

Australia’s corporate landscape is littered with the tombstones of many once-large companies, some with market capitalisations in the billions of dollars. How could such large, seemingly financially robust, companies go under? Quite easily, actually, although the string of events leading up to each individual collapse were totally unique. But the one common factor amongst all of them was their enormous debt obligations, and their inability to generate enough cash to meet their loan payments on time.

Some of the biggest ASX collapses in Australian corporate history include:

  • Qintex (1991)
  • Bond Corporation (1992)
  • HIH (2001)
  • Onetel (2001)
  • Allco Finance Group (2008)
  • Centro Retail Group (2008 – since restructured)
  • Babcock and Brown (2009)
  • Timbercorp (2009)
  • Great Southern Plantations (2009)
  • Gunns (2012)
  • Hastie Group (2012)
  • Dick Smith Holdings (2016)

And many, many more!

Investors who bought into these companies when they were trading at all-time highs share one thing in common with those that bought the stock one month prior to collapse… They lost the lot! So don’t fall into the trap of thinking a company is ‘too big to fail’ because history has proven this statement wrong, and no doubt it will prove it at some point in the future again.

Easily avoid these disasters

Stock Doctor members are able to easily avoid such disasters without stress and hours of research. Stock Doctor displays the financial health of every business on the ASX allowing you to easily identify and screen the level of Financial Risk a company is exposed to.

With three quarters of the market exposed to unacceptable levels of risk it is a minefield for many investors who do not possess the insights Stock Doctor provides. As investors we need to ensure that at all times we are exposed only to the very best, most fundamentally sound businesses on the exchange. Only by doing this can we have the confidence, control and peace of mind to make fully informed investment decisions.

Fundamental analysis is key

Now, the underlying reasons behind every corporate collapse are very specific. Some collapses are as a result of extremely poor management, or the combination of poor management and external events, and some are because of outright corporate fraud. But the tell-tale signs are usually there well beforehand. Like a good forensic scientist, investors need to use stock research tools to the financial digging. Research confirms Lincoln’s Financial Health methodology accurately identified more than 95% of failed businesses, many years before they went bankrupt.

This is why it our first and most important Golden Rule, Golden Rule #1 – Financial Health within our “9 Golden Rules of successful investing” framework.

Balance sheets and debt are at the heart of a business

Companies with a strong balance sheet and manageable levels of debt are less likely to undertake dilutive capital raisings, or worse still go broke under the weight of rising interest bills. Borrowing however is a necessary part of being in business, because it enables companies to fund their expansion plans more aggressively than if their activities were funded directly from cash reserves. But all companies that borrow funds must be prepared to face the music if they fail to pay off their debts.

The composition of the balance sheet is also important. Sufficient cash balances are required to fund day-to-day operations such as rent, utilities and salaries. Inventories are also an important asset for most industrial companies as they represent a main source of revenue and may be readily liquidated into cash if necessary.

Similar to inventories, trade receivables can be monetised. However one needs to note the ‘age’ of these receivables because the longer they have been outstanding, the harder it is to collect. Bad debt expenses will typically leave a bitter taste. Goodwill and other intangibles, such as trademarks and patents, are subjective in value and may be difficult to convince potential buys to purchase at its full value when a company is in dire straits. Hence we advise to look at the book value of a company, excluding intangible assets.

Financial Health Model White Paper