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The fault line under the stock market

23 September 2014  |  Investing

Fault line"Financial catastrophe" is a strong phrase. But that is the description of CPA Australia after it looked at almost 16,000 annual reports from listed companies between 2005 and 2013. The CPA found that 11 per cent more listed companies attracted financial distress warnings in 2013 than was the case during the global financial crisis.

The report is based on the findings of independent auditors, who are required to flag in a company's annual report if they believe there is "significant uncertainty" in a company's ability to continue as a going concern.

The Age's Adele Ferguson analyses the findings:

 

What is interesting is the big four auditors report a lower percentage of going concern warnings than small audit firms. Whether this reflects the fact that the big four firms audit bigger companies, which are more bulletproof when it comes to a slowdown in the economy, is worth investigating.

The report shows that almost a third of ASX-listed companies attracted "going concern" warnings from independent auditors and that most of the warnings were concentrated in the bottom 500 listed companies.

Put simply, 58 per cent of Australia's smallest 500 listed companies in 2013 attracted going concern warnings by auditors. This is something CPA boss Alex Malley describes as a "sobering reminder of the fragility of the Australian economy and the challenges many businesses face".

When the numbers are further broken down, energy and mining companies stand out like beacons, with more than 40 per cent of these sectors facing serious financial uncertainty. But according to the report, going concern warnings also  increased in sectors including consumer staples, industrials, healthcare and utilities.

The CPA survey of audit reports of listed companies comes against a backdrop of company insolvency blowing out in the three months to June 30, 2014. The quarterly results show a 24 per cent rise in creditor voluntary liquidations, a 28 per cent rise in voluntary administrations and a 16 per cent rise in receiverships. Construction was one of the worst hit industries, with 18 per cent being placed into administration in the latest quarter.

But these official figures are the tip of the iceberg. The brutal reality is there is often a time lag between companies in financial distress and being wound up, given the cost of wind-ups and the few cents in the dollar creditors generally get back.

It suggests an insolvency time bomb could be ticking away in the small- to medium-sized sector, which is a huge concern for the broader economy as SMEs employ 70 per cent of private sector employees."

 

The lesson for SMSF investors is that the tactic that many have preferred, of concentrating on the high dividend paying oligopolies, is probably far safer. In particular, small mining stocks are vulnerable to the inevitable easing of prices in the commodity market. It is often assumed that the higher the risk, the higher the reward. But with the many companies that the CPA has looked at, the emphasis is very much on the risks.

 



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