Profit warnings: what they are and what to do if a company issues one
This article explores what a profit warning is and what you should consider before acting.
Summary
Investing can offer better returns than a savings account but can be risky.
If you invest in a company, you should always be aware of the risk of profit warnings.
Profit warnings can happen to any company, whether it’s a small one or worth billions.
What you should do following a profit warning depends on the circumstances.
Getting expert financial advice can help you with your investment strategy and portfolio.
What is a profit warning?
If you invest in a company and they issue a profit warning, investors' reactions can be alarming and make it tempting to act swiftly and sell. But is this the right way to react?
A profit warning is when a listed company reports annual profits that are “materially below” management or market expectations.
This announcement usually includes information about why the company is facing materially lower profits than anticipated and will likely explore potential solutions in a future statement.
It’s worth flagging that as a company’s share price is based on anticipated future profits set by analysts if profits are expected to be materially lower, the share price may change.
What can trigger a profit warning?
There are many reasons why a company may issue a profit warning, including:
The impact of higher interest rates
Higher costs for energy, staff and materials
Supply chain disruption
Delayed business spending
One of the reasons why businesses may delay spending is due to the uncertain economic outlook and weaker consumer confidence.
How much impact does a profit warning have on a company’s share price?
A profit warning can spook investors.
According to EY Parthenon, in the fourth quarter of 2023, companies experienced a median fall (on the day of warning) of 18.8%, the highest in over four years.
In some cases, profit warnings can have an even bigger impact.
For example, shares in Dr. Martens crashed in April 2024 by nearly 30% after a tough year of US trading triggered a profit warning, and the chief executive announced his resignation.
Do profit warnings matter?
Investors should always take note of a profit warning, especially if they are invested in the company issuing one.
A profit warning could indicate issues with the company, the sector it operates in, or the US economy, including consumer confidence.
While some issues that cause a profit warning may be persistent, others may be short-term or out of a company’s control.
Even the biggest names in the world can deliver a warning.
Apple announced its first profit warning in 16 years in 2019 as the business struggled in China, while in the same year, Walgreens lowered its profit growth forecast for the year after missing its second quarter target.
This shows a profit warning doesn’t necessarily mean a revival in a company’s fortunes is impossible.
However, if companies issue multiple profit warnings within a year, it can spark concern for investors.
What you should consider if a company issues a profit warning?
If a company issues a profit warning, the first thing you shouldn’t do is not panic.
While some profit warnings can result in further disappointment, some can just be a bump in the road.
Profit warnings could also be due to a difference between company guidance and investor expectations, with the former overpromising without considering all the headwinds.
It’s difficult to determine exactly what to do when a company issues a profit warning, as each situation differs.
First, it’s a good idea to examine why the profit warning was issued – is it due to short-term factors or issues? Or is the issue more prevalent in the sector or globally?
Figuring out the problem and the company’s plan is vital, as this could be a buying opportunity if you’re confident in the long-term fundamentals. However, if this is due to more competition or weaker trading conditions, there may be future warnings.
If you’re keen to minimize the risk of warnings, you could invest in profitable companies with a decent history of reliable profits and cash flow, known as “bond proxies.”
However, it’s worth noting these companies can have high valuations, meaning investing in a bond proxy can be expensive - and profit warnings can still occur.
Also, the higher the valuation, the higher the profit expectations. If these aren’t met, the share price can crash.
You can also be proactive and analyze any financial statements issued by a company you have a stake in. You can find a company's financial information via the U.S. Securities and Exchange Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR) database.
This provides free public access to corporate information, including registration statements, prospectuses, and periodic reports filed on Forms 10-K (audited annual financial statements) and 10-Q (unaudited quarterly financial statements).
When a company releases a financial statement, some key areas to look at include:
Are like-for-like sales slowing?
Are costs rising?
Are debt levels increasing?
Are cash reserves healthy?
Are stock levels declining? This can reveal weakening demand.
Get expert investment advice
Being an engaged investor can be a lot of hard work and research, but it doesn’t need to be.
If you’re looking for help with investing, whether you’re just starting your journey or hoping to optimize your portfolio or strategy, a financial advisor can help.
Unbiased can connect you with an SEC-regulated financial advisor. Simply answer a few questions about your financial needs, and we will quickly match you with an advisor suited to meet your needs.
Senior Content Writer
Lisa-Marie Voneshen is a Senior Content Writer at Unbiased. She is an award-winning journalist with nearly a decade of experience writing and editing content across various areas, including personal finance and investing.