Want to stick around for an earnings earthquake? No? Then protect yourself with our early warning system.
I missed an earthquake by five minutes last month. Instead of thanking Ronson, the God of Close Shaves I cursed my luck that the most exciting thing to happen in Cerrig y Druidion in the last ten years passed me by even though I was there. I happened to be driving the one mile from my sister's house to my mother's and my car tyres insulated me from the shock. It was only a minor tremor but that's big news in Denbighshire.
Excitement of the wrong sort is an earthquake in your portfolio. Like geological fault lines it's possible to spot some locations in the City where big trouble may be about to strike. Like fault lines it's also hard to know exactly when and where the plates will suddenly shift.
Last week Scottish TV and Virgin radio owner SMG
(LSE: SMG)
warned of weak TV advertising sales and consequently "a potential breach of certain of its financial covenants." The shares fell 20% to 55.5p. However only last month UTV
(LSE: UTV)
broke off merger talks after failing to agree a price with SMG's board. The main commercial operator ITV
(LSE: ITV)
would make a logical acquirer but has so far dismissed the idea.
Putting the word "covenants" in a news release is the City equivalent of pulling the pin out of a grenade. SMG's bankers have the whip hand and despite a reassurance that "a satisfactory outcome is expected" there's no telling what will happen. The shares could slump further if its bankers want to make things difficult or advertisers continue to shun ITV1. On the other hand holders would see a surge if the firm made it to safe harbour with new lending terms to anchor it. The newly minimised price may look tempting to potential bidders who have stayed their hand.
So even though SMG has strong brands and is 40% cheaper than six months ago this is a classic fault line because the situation can't be evaluated. There are too many unknowns with serious consequences, up and down, for the share price.
Checklist
Although the shares often fall when one of these warnings flashes red there may be much worse to come. It's best to stay clear.
- Breach of covenants: Look for weasel phrases like "new financing arrangements" or "in discussion with our bankers" which often mean the company is at risk of a breach.
- Accounting irregularity or profit restatement: Even if the company says it's a minor oversight it's evidence of a slackness or deliberate manipulation that often goes deep. It did at Mayflower and iSoft
(LSE: IOT)
.
- Regulatory threat: Governments succumb to political pressure or expediency. The often threatened clampdown on US gambling finally happened, toppling PartyGaming's
(LSE: PRTY)
pile of chips amongst others.
- Political uncertainty: The swing of Peru to the left hit copper mine owner MonterricoMetals
(LSE: MNA)
. It certainly caught me out.
- Bandwagons: These often lead to oversupply and collapsing prices. The broadband boom and price war is a double edged sword for CarphoneWarehouse
(LSE: CPW)
.
- Make or break dependency on a single event: Examples are a drug trial, court case or loss of key contract. Regal Petroleum
(LSE: RPT)
has gyrated as it lost then won its case over oil rights in the Ukraine.
- Damaged reputation:Jarvis
(LSE: JRVS)
was almost destroyed as customers deserted it after its being accused of causing the Potters Bar rail crash and on numerous reports of problems on its public sector PFI projects. Many thought the storm would pass but it was impossible to evaluate the damage from outside.
Alun owns shares in Monterrico Metals
