Beware of Waving Red Flags

09/30/2013 9:00 am EST

Focus: STOCKS

James Oberweis

President, Oberweis Asset Management, Inc.

Small-cap expert Jim Oberweis details the red flags that investors should watch out for in companies' financial reports without having to read the whole thing.

SPEAKER 1:  Hi.  My guest today is Jim Oberweis.  Thanks Jim for coming by.  We appreciate it.  Always good to see you.

JIM:  Pleasure, you likewise.

SPEAKER 1:  I love your newsletter and recently you wrote something about red flags that investors should be looking for in financial reporting and that’s kind of funny because how many investors really read the financial reports.  You know they listen to the headlines and it’s like oh that sounds good, I think I’ll buy it.  I’ll put all of that in my portfolio.

JIM:  And it’s really interesting because we’re kind of overwhelmed with information these days.  All the information is there, it just sometimes takes some time to kind of dig through.  I’ve been doing this now 19 years and I’ve seen lots of CEOs and I’ve never seen anyone who doesn’t love their company, so I think you have to be really careful in sorting through kind of the good from the bad.

SPEAKER 1:  That’s why I love Warren Buffet’s reports.  It’s like well you know we did okay here but kind of screwed up here and you don’t see too much of that.

JIM:  No, that is definitely the exception.

SPEAKER 1:  So what are some of the red flags that investors should actually look for that don’t make them read the entire 10K because we know they’re not going to do that.

JIM:  Absolutely.  Honestly we just spend a lot of time looking at the numbers more than what management says.  I’d be highly skeptical.  If you come in with a highly skeptical attitude, look for things like increases in inventories that are difficult to explain or companies blaming the weather for (INAUDIBLE), like Coca Cola blaming Indian monsoon season this year on missing their quarterly numbers.  That stuff just doesn’t fly.  What we find many times is when growth rates start to slow a little bit, a lot of times there are more bad quarters to come, so be fairly quick to the trigger to exit stock when the first signs of trouble are brewing.  We also look for accounting that perhaps is a little bit more aggressive than one might expect.  We prefer to see conservative accounting quality.

SPEAKER 1:  Most of the companies that you’re looking at are small-cap companies so that their financial statements tend to be more visible than what you would if you we’re buying Exxon or something like that. 

JIM:  That’s right.  It’s much easier to analyze a company when there’s one or two products or a product line versus a _____ like Exxon.

SPEAKER 1:  Is that why you chose that sector?  Is that one of the reasons?

JIM:  You know we try to find areas where there is inefficient pricing with others where there are segments of the market where there are just not a lot of people looking at them where we think we can add value.  The problem with a company like General Electric or Microsoft is there are so many analysts tracking…

SPEAKER 1:  Yeah, 37, 42, yes.

JIM:  Exactly.  It’s really hard to be smarter than that collective group, but sometimes in small-cap stocks if you’re quick to recognize change and you are watching and doing your homework and looking through why companies are growing, sometimes you can be a little bit quicker than others and add excess return.

SPEAKER 1:  Absolutely.  Thanks for joining me Jim.

JIM:  Pleasure, thanks.

SPEAKER 1:  Thanks for being with us on the Moneyshow.com Video Network.

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