Profit warning

economic-dictionary

A profit warning is a warning about the profits of a company listed on equity markets, which may lead to strong increases or falls, although generally, it anticipates a strong deterioration in them.

The profit warning is a risk alert for the investors of the organization that issues the warning. It indicates that the performance of the company is deteriorating and that it will make a lower profit than expected.

Scope of the profit warning and shareholder's right to information

Listed companies have access to huge amounts of capital compared to unlisted companies. Therefore, they must comply with a series of requirements related to providing information on their financial evolution and other aspects. The objective is for the investor to have all the necessary information to analyze and carefully decide whether or not it is a good idea to invest in it.

Thus, listed companies are required by law to present their results and their future financial estimates or projections. They must submit an annual financial report together with their audited annual accounts and management report, two semi-annual financial reports and two intermediate management statements. In them they must report on operations and significant events, financial situation and results on a quarterly basis.

Companies launch these notices to inform their shareholders that they will not be able to achieve the profit figure they had previously projected or even that they could incur losses.

Causes of profit warning

The causes that can lead to reductions in financial forecasts have a dual nature, being able to intermingle with each other:

  • Short-term or structural, the difference of which is that they are specific reasons or, on the contrary, habitual or permanent, respectively.
  • Internal or external, whose difference lies in whether they are produced from within the company or, on the contrary, they come from outside the organization, respectively.

Thus, below are some examples of causes that combine the essence of both groups and that can lead the company to issue a profit warning at a certain time.

It is important to identify the causes that have led the company to be in this situation and for the management team to be able to find new formulas and strategies that will return it to the safe zone.

It can be sensed that the ideal would be for internal structural causes to become cyclical in order to overcome them.

Consequences of a profit warning

Most often, investors go to the market to sell the company's shares. So the share price will drop drastically, depending on the volume of sales that occur.

There are times when the market has already discounted a deterioration of the company. In other words, investors are already taking into account that the company is going through problems. In this case, there may not be such a sharp drop in the share price.

There are also situations in which the price can result in an increase when the published result has not been as poor as the analysts predicted.

In addition, there have also been situations in which a company ends up affecting others in the same sector.

How to act in the face of a profit warning

It is important to identify the causes that have caused it, temporary or structural, internal or external. When it comes to quality businesses, well managed or with little debt, profit warnings can become good buying opportunities if you are a long-term investor.

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