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3 things the Debenhams debacle reminds Foolish investors

Arguably one of the biggest stories of the week, at least in the business world, was news battered high street chain Debenhams (LSE: DEBS) had gone into administration after rejecting an offer by Mike Ashley’s Sports Direct to save the business on the condition he was made CEO.

The shares are currently suspended and, while stores continue to trade, remaining shareholders, including Ashley, will likely be wiped out. Investing can be brutal sometimes.

That said, I do believe Debenham’s situation is a useful reminder of things that Foolish investors always need to be on the lookout for.

1. Big debt

Debenhams has debt — £621m of it. By contrast, the market capitalisation of the whole company was just £23m or so when shares were suspended on Tuesday. 

One of the first things to look for when sizing up a potential investment — particularly in uncertain political and economic times — is how much debt the company carries. Ideally, it won’t have any at all, or at least a net cash position (i.e. more cash on the balance sheet than debt).

The amount of money owed by a company can be found in its latest set of results, although bear in mind that the gap between when this number is calculated and then revealed to the market can be several months.  

2. Failing to adapt

Another huge issue with Debenhams was its failure to adapt to changing consumer tastes quick enough. As more of us moved online to do our shopping, the company saw a significant drop in the numbers of people visiting its tired stores (which also have expensive, long-term leases).

There’s also something to be said for monitoring a retailer’s image among consumers. If you or people you know wouldn’t shop there, why hold its shares? Alternatively, ask yourself whether you’d create the company today if it didn’t already exist. If you wouldn’t, that’s a warning sign.

3. High short interest

I’ve recently become increasingly interested in the activity of short sellers. For those new to investing, these are people bearish on a company’s future and therefore bet on its share price falling. 

Since their losses are technically infinite if a share price jumps, short sellers must be confident in their research. No surprise that Debenhams has been one of the most shorted stocks on the market for some time.

If you’ve purchased any company’s shares without proper research and notice the amount of short-selling has increased, or is high, you may want to question whether it’s a good idea to remain invested.

Get out while you can

Here at the Fool, we’re fans of investing for the long term. Trading shares might sound exciting but it’s actually hard to do well on a consistent basis. Moreover, the high commissions you pay inevitably eat into whatever profit you are able to scratch out. 

Nevertheless, it can sometimes be right to sell if you spot trouble ahead. Taking a loss is painful, but you’ll be thanking yourself if the company later suffers the same fate as Debenhams.

Its shares were priced around 54p two years ago. They were suspended at 1.83p. There was plenty of time to get out and yet many didn’t. Sometimes, it pays to trust your gut.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.