Well, the votes are in. Yesterday, I offered to do a second column on signs that could have warned investors of potential trouble at Xybernaut (NASDAQ:XYBR). The idea appears to be a popular one, so let's get to it.
We've already covered three clues to Xybernaut's ill health, apparent before last Thursday:
- Voluminous issuance of press releases.
- Rising sales, unaccompanied by rising profits.
- Massive stock dilution.
I won't belabor those points today. If you missed the first column, you can find it here. Today, I'll highlight a few of the other clues that something was amiss with this company. My aim remains not to criticize, but to use the lessons of last week's blowup while they're fresh in investors' minds -- in other words, to highlight the red flags now, so that when you see them in other companies down the road, you'll more readily recognize their significance. Let's begin.
Over-promising, under-delivering: Everyone loves a pleasant surprise, and investors in particular love to have their companies say they'll do "X" -- and then exceed it. It's when companies do the opposite that people get upset. In late 2002, Xybernaut management assured investors that by Q2 2003, the company would be GAAP-profitable. and $38.4 million in losses later, profitability is still nowhere in sight. In Q2 2003, the company stated that it had reached the point where it would no longer need to issue new shares to finance its operations. and 50 million shares later, the company's latest press release confirms that it must find a way to continue issuing more shares, or else be unable "to meet its obligations as they come due."
Stock shenanigans: Xybernaut has issued enough stock in private placements over recent years to create several 5% bloc-owners. Yet none of the individuals who bought 5% or more of the stock are ever reported as owning that amount. Judging from the Securities and Exchange Commission filings, it appears that these buyers resold their stock nearly as soon as they acquired it. That's not exactly a vote of confidence in the company.
Minimal insider ownership: It's always reassuring to know that management is in the same boat as the individual outside shareholder. That's why Fools prefer to invest in small caps that have at least 10% insider ownership. Xybernaut's executive team, in contrast, owns less than 2%. Count that as a vote of no confidence by the people who know the company best.
Management turnover: And speaking of no confidence, the post of chief financial officer at Xybernaut changed hands twice in three years. Rapid turnover in the executive ranks doesn't necessarily sound the bell of doom, but it should at least set off alarms.
In closing, let me emphasize that it's easy to ignore red flags like these when you "believe" in a company. And that's OK. We've all suspended disbelief, ignored warning signs, and suffered the consequences at one time or another. I've done it. Other Fools have done it. The important thing is to recognize what mistakes you've made in the past, because that's the only way you'll recognize them again in the future -- in time to avoid making them.
On that note, here's wishing you all many successful years of Foolish investing, and many mistakes averted in years to come.
Fool contributor Rich Smith has no position in any of the companies mentioned in this article.
