What is a 'Red Flag'

A red flag is an indicator of potential problems with a security, such as any undesirable characteristic that stands out to an analyst as it pertains to a company's stock, financial statements or negative news reports. Because there are many different methods used to pick stocks and investments, there are many different types of red flag. A red flag for one investor might be desirable to another, as in the example of how low institutional ownership might be a positive for someone looking for undiscovered companies but a negative for a pension fund that searches out blue chips.


There is no universal standard for identifying red flags. The method used to detect problems with an investment opportunity depends on the research methodology an investor employs.

Problems With Financial Statements

Regarding publicly traded companies, red flags may appear in quarterly financial statements compiled by a company's chief financial officer, auditor or accountant. These red flags may indicate some financial distress or underlying problem within the company. Unfortunately, red flags may not be readily apparent on a financial statement, and it may take some extra digging to get to the root of the problem. Red flags usually appear consistently in reports for several quarters in a row, but a good rule of thumb is to examine three years' worth of reports to make an informed investment decision.

Examples of Red Flags

Investors can look at revenue trends to spot a company's growth potential. Several quarters in a row of downward-trending revenue can spell doom for a company. Measures needed to rectify the situation aren't good either if a company needs to lay off employees or cut wasteful spending.

When a company takes on more debt without adding value to the business, the debt-to-equity ratio could rise above 100%. This could point towards cash flow problem as the business may have trouble paying down its debts on a regular basis.

A large stockpile of cash on hand doesn't necessarily denote a healthy company. A business that moves cash up and down, on a regular basis, indicates buying raw materials and then selling a finished product. Large amounts of cash may show accounts are being paid but no new money is coming into the firm.

Rising accounts receivables and high inventories may mean a company is having trouble selling its products or services. If this trend continues for several quarters, investors have to ask themselves why the company seems to be unable to empty its warehouses.

Due Diligence

The best way investors can avoid making a bad decision is to pay attention to red flags on financial statements. That's where expert analysis comes into play — amateur investors might consider reading expert analysis on various companies to make an informed selection about a stock, security or business opportunity.

  1. Financial Statement Analysis

    The process of reviewing and evaluating a company's financial ...
  2. Fair And Accurate Credit Transactions ...

    The Fair and Accurate Credit Transactions Act (FACTA) is a U.S. ...
  3. Red Herring

    A preliminary prospectus filed by a company with the Securities ...
  4. Red Candlestick

    The component of a candlestick chart that represents a downward ...
  5. Stock Analysis

    Stock analysis is the evaluation of a particular trading instrument, ...
  6. Comparative Statement

    A statement which compares financial data from different periods ...
Related Articles
  1. Investing

    Look For These Red Flags In The Income Statement

    Companies can overstate their revenues and understate their losses to boost investor confidence. Learn how to spot the these red flags in income statements.
  2. Taxes

    Avoid an Audit: 6 "Red Flags" You Should Know

    Don't make yourself a target - steer clear of these attention-grabbing tax-filing practices.
  3. Insurance

    Financial Stocks Breaking to the Upside

    These financial stocks recently broke above resistance, signaling another move to the upside.
  4. Trading

    Continuation Patterns: Rectangles and Pennants

    Flags and pennants indicate direction of activity of the prevailing trend. Learn how.
  5. Trading

    These Red Flags Could Signal A Change In Trend

    Early warning signals allow traders to take action before a change in trend traps the prevailing crowd.
  6. Personal Finance

    Find an Advisor Who Will Work in Your Best Interest

    A certified financial planner who is a fiduciary and works in a fee-only capacity is your best bet. Here's why.
  7. Trading

    Profiting From Carry Trade Candidates

    Capitalize on the yield of the interest rate differential by using flags and pennants.
  8. Investing

    Has Red Robin's Valuation Outpaced Fundamentals?

    Shares of Red Robin rose more than 20 percent after a well-received earnings report. Analyze the valuation.
  1. What are the most common continuation patterns?

    Learn more about three of the most common types of continuation patterns – triangles, pennants and flags -- and how to differentiate ... Read Answer >>
  2. In what ways can a portfolio be over-diversified?

    Learn how it is possible to over-diversify an investment portfolio, and find out what role opportunity cost plays in financial ... Read Answer >>
  3. What are the fundamental differences between a pennant pattern and a flag pattern?

    Understand the basics of both the flag and pennant continuation patterns, their similarities and differences, and how each ... Read Answer >>
  4. What information should I look at on a publicly traded company for use in fundamental ...

    Learn what information is important in fundamental analysis of a publicly traded company and how to use it to assess the ... Read Answer >>
Hot Definitions
  1. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  2. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  3. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  4. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  5. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  6. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
Trading Center