Ready to invest? Five red flags to watch for in company reports

Frances Cook talks to veteran financial journalist Paul McBeth about what to look out for in a company report, before you invest your money in that company.

If you're investing in the sharemarket and trying to figure out which companies are worth backing, there’s a good chance you've been told to "read the reports".

Sounds simple enough, until you're 20 pages deep in a statement packed with jargon, fair value adjustments, and EBITDA breakdowns, wondering what any of it actually means.

So how do you cut through the noise, especially if you're not a professional analyst with Bloomberg screens and a finance degree?

Veteran financial journalist Paul McBeth, now editor of the independent business publication The Bottom Line, spent more than 15 years covering the corporate sector. He read earnings reports for a living, and reported through the chaos of the 2008 GFC and Covid 19 market crashes.

So he’s seen the curly side of the business world, and has experience watching for subtle red flags.

Here are five things he says matter most when you’re trying to figure out whether a company is worth your money.

Before you dive into spreadsheets and profit margins, take a step back and ask: What kind of company is this?

A software startup trying to grow as fast as possible will look different than an established logistics giant like Mainfreight. And that's okay; their numbers should reflect their different priorities.

"If I'm owning, say, Xero shares 15 years ago, I'd want to see that top line [total revenue] growing and the cash burn staying manageable," McBeth says.

"You wouldn't be too worried about the bottom line [net revenue or profit]. You're worrying about [their ability to attract new] customers."

In contrast, if you’re looking at a company like Fletcher Building, the expectations are different.

"Now you're hoping they can turn things around. You want them to hive off some businesses that don’t seem part of the group anymore, and not do it at too big a loss," he says.

Understanding what the company is trying to do helps you interpret whether the numbers make sense, or whether the business might be drifting off course.

Revenue and profit can be massaged. Cash? Less so.

McBeth says one of the first things he looks at in any company report is operating cash flow, aka the real money coming in and out of the business.

"I remember it being described to me as: profit and loss is food. Cash is oxygen," he says. "You can go a couple of days without food. But oxygen? You’re done."

He warns that changes in accounting rules and fair value adjustments can make profit numbers misleading.

So while the bottom line matters, it’s often not the full story.

If a company looks profitable on paper but is struggling to generate real cash, that’s a red flag.

A common trap for retail investors is assuming they're just not smart enough to get it.

That’s something that companies may try to use against you.

"If you can't work out how they’ve gone within the first three paragraphs, then you probably want to be a little skeptical," McBeth says.

"The easier it is to wrap your head around how they’ve done or what they want to do, that should give you confidence."

He’s especially wary of companies raising fresh capital without clearly explaining why.

"If I can't see what they're spending the money on? Worry about that. If it’s just to repay bank debt, maybe the previous owners have already taken a payday."

Transparency is a green flag. If it’s all jargon and deflection, you have to ask why.

Yes, earnings matter. But sometimes, what you hear about a company is just as important.

If a business has high staff turnover, management drama, or a bad reputation in the industry, that’s a clue.

"If people aren't happy, that's normally a big red flag," McBeth said.

"It tells you the board isn't paying enough attention to what's going on. And the board acts on behalf of the owners, the shareholders."

On the flip side, positive whispers can be a sign of long-term strength.

McBeth gives the example of a large company that has a reputation for being a very good employer. "They’ve got staff buy-in, a clear long-term vision, and alignment between the board, the management, and the people who actually work there," he says.

“That stuff matters."

Trying to pick short-term winners and beat professional traders at their own game is a tough ask. McBeth says it’s smarter to focus on your long-term intention.

"If you want a short-term gain, that’s trading. That’s not quite investing.”

Real investing, he says, means thinking in decades.

"If you're taking a long-term view, you're investing in the ability of that company to grow over time.

“It should be 20-plus years, not five. That’s the time frame where compound growth actually kicks in."

Retail investors can’t compete on speed. The big investing companies react to news in seconds, using data and tools most of us will never have access to.

But retail investors do have one major edge: patience, and time.

Unlike fund managers, you don’t have quarterly reports or investor expectations forcing you to act.

You can take your time, build conviction, and only invest when something actually makes sense.

This column is general information only and should not be taken as individual financial advice.