Profit warning

Listed companies must notify the market in a timely manner of any major developments or information that would, if generally available, be likely to have a significant effect on the company’s share price. These rules are meant to prevent insiders from gaining an advantage over other investors by having an opportunity to trade using price-sensitive information before anyone else gets to hear about it.

Some of the major events that need to be disclosed are obvious: mergers, legal decisions that go against the company, and any changes to top management. Another situation where the company may have to make an announcement is if management realises that its profits are going to be significantly lower than the market currently expects.

In cases where the company has made official profit forecasts, or implied in conversations with analysts that it expects a certain outcome, the law is clear that it has to notify the market of any major changes. If the company has deliberately remained silent, and analysts have come to their own conclusions, it has more leeway on whether or not to disclose, especially if the new forecasts are themselves uncertain. However, many companies choose to disclose pre-emptively anyway.

Profit warnings can often look to unwary investors like tempting buying opportunities – and sometimes they are. But remember that the old City saying “profit warnings come in threes” exists for a reason. The initial profit warning may simply be the start of the revelations – a problem that management had originally hoped would go away may merely get worse, and you often have to see heads rolling before a genuine turnaround can begin. So do your homework before you buy a troubled stock (or “catch a falling knife”, as the City jargon has it).