Why we screen for red flags
Earlier in this module we said one of our four questions is "what could go wrong?" Red flags are how we answer it.
A "red flag" is a pattern in the financial statements, governance disclosures, or auditor's report that - historically, across thousands of Indian listed companies - has been associated with bad outcomes for shareholders. Not every red flag becomes a problem. But almost every problem started with one or more red flags being visible years before the stock collapsed.
The reason most retail portfolios get hurt: the flags were there, no one looked.
The five most common patterns
| Pattern | Where it lives | Why it matters |
|---|---|---|
| Cash conversion gap | P&L vs cash flow | Profits not turning into cash |
| Related-party transactions | Annual report schedule | Value transferred away from minority shareholders |
| Contingent liabilities | Notes to accounts | Hidden off-balance-sheet exposure |
| Working-capital build | Balance sheet over time | Customers paying slower, inventory piling up |
| Promoter pledge | Shareholding pattern | Forced sale risk if loan defaults |