Profit warning

A profit warning is an announcement by a company that its profits will be significantly lower than current market expectations. These expectations may either be based on the company's own previous estimates, or may just be a market consensus.

The profit warning is not usually formally called one by the issuer, and it may merely be a paragraph in an announcement that would be made in the usual course of events: typically a trading statement. The sometimes low profile form of a profit warning does not detract from its importance.

A profit warning, by its nature, means most investors will have to revise their forecasts. The price will also move in reaction to a profit warning, so buy/sell decisions may change either way: you may well take the view that a sharp fall in price is an over-reaction to a profit warning, for example.

When re-evaluating a share in the light of a profit warning, it is well worth thinking about cockroach theory and think about how likely it is that further problems come to light. Is the profit warning a one off event? Is the the result of internal problems (such as bad management) or external (such as weak demand in the sector)? Does the cause indicate any continuing trend? Does it expose any weakness of the business model, product, or brand?

Copyright Graeme Pietersz © 2005-2020