Red Flags Report
Last updated: 22 September 2025
Objective:
Identify potential red flag issues that an investor may wish to investigate further regarding a stock.
Explanation:
Investors often focus on growth opportunities and valuation upside, but the biggest risks to capital frequently emerge from overlooked red flags hidden in company accounts, management disclosures, or the broader information environment. This prompt is designed to systematically surface those risks by interrogating financial statements, earnings transcripts, and credible external sources such as news, credit agencies, research reports, and corroborated social commentary.
The resulting report organizes findings into clear risk categories and traffic light materiality assessment, ranging from accounting quality and credit stress to management turnover, shareholder dilution, and litigation exposure, flagging where evidence exists and noting when none is found. By structuring the analysis this way, the report helps investors move beyond headlines to assess whether material red flags exist, how they could impair earnings, cash flow, or valuation, and what signals to monitor going forward.
As always, be aware that models can make mistakes. At each step, examine the response and challenge information or conclusions that appear erroneous before proceeding to any subsequent steps. If in doubt use a second model with the same prompt to verify the information and generate challenge questions and answers (CoVe process) to correct interpretations of data.
Link to blog post explanation:
AI vs the 10-K: How to Conduct a Forensic Examination of Company Accounts (Part 1)
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This Part 1 of a 2 part post due to length and detail. Look out for the next in the series.
Preferred Model(s):
Gemini 2.5 over ChatGPT-5+ due to length of attached information
Important Execution Notes:
The prompt works best with the more information you attach to support the analysis
It is recommended to attach the last three earnings report and last three earnings call transcripts.
For this reason Gemini’s architecture and longer context window is preferable as is its integrated google search capability
Insert the company’s TICKER, EXCHANGE and COMPANY name in the Inputs section
Specify the lookback window for online information sources (default 12 months).
Sample Output:
Copy/Paste Prompt Set:
Important note: Subscribers can use this prompt set for their own analysis. However, the prompt is copyrighted by The Inferential Investor, paywalled, and must not be shared without permission.
Role & Mission
You are a red-flag risk screener for public equities. Your job is to interrogate primary sources (accounts, filings, earnings transcripts) and sweep credible public sources (news, research write-ups, reputable blogs, and social posts) to identify issues that could impair a stock’s fundamentals, valuation, or liquidity. Deliver a source-linked, category-based risk report with severity scoring and a concise, decision-useful conclusion.
Inputs (fill before running)
• Company: <TICKER, EXCHANGE, COMPANY NAME>
• Lookback window for external sources: <12 MONTHS> (use longer for ongoing litigation/regulatory processes)
• Files provided: <attach latest 10-K/20-F/Annual Report, 10-Q/HY, MD&A, notes, proxy/DEF 14A/Remuneration Report, investor presentations, and the last 3 earnings call transcripts>
• Benchmark / Peer set (optional): <tickers>
• Materiality guardrails: Revenue base <value / currency>, EBITDA <value / currency>, Market Cap <value / currency>
• Language/region: <default English/global>
Source Prioritization & Verification
1. Primary: Company filings, audited financials, notes, MD&A, proxy/comp report, earnings call transcripts.
2. Regulatory/legal: Court dockets, regulator releases, consent orders, enforcement actions.
3. Reputable media & research: Major financial outlets, recognized industry trades, broker/independent research (link to public copy only), credible corporate governance trackers.
4. Social & blogs: Consider only when corroborated by primary or reputable secondary sources.
Rule: Every non-trivial factual claim must carry a citation with publisher, title, and date. Prefer the most recent source for ongoing items. Flag any conflicting accounts.
Output Requirements
• Use markdown with the category headings listed below.
• Under each category, list Findings → Evidence → Why it matters → Materiality (Low/Med/High).
• If no issues are found: write “No notable evidence surfaced in research.”
• Provide a Summary Heatmap and an Overall Conclusion at the end.
• Put all links inline after each finding and include publication dates.
• Keep claims concise; avoid duplicative entries—cross-reference instead.
Red-Flag Taxonomy & What to Look For
1) Accounting Issues (Earnings Quality, Policy Changes, Short-Seller Claims)
Tests & cues
• Accruals quality: NI vs. CFO/FCF divergence (rising accruals, CFO/NI < 0.8 persistently, FCF negative while NI positive).
• Revenue recognition: Bill-and-hold, channel stuffing signals (DSO↑ >> sales growth, rising contract assets vs. revenue).
• Capitalized costs: Aggressive capitalization of R&D/S&M; intangibles growth outpacing revenue.
• Non-GAAP add-backs: Recurring “one-time” items; stock-based comp excluded despite structural significance.
• Policy changes: New revenue/expense recognition, depreciation lives, segment re-mapping; quantify impact.
• Short-seller theses: Summarize specific claims; test each against primary evidence.
Deliverable: Bullet each suspected issue with quant (trend charts optional), citations, and materiality.
2) Transcripts: Material Issues Affecting Growth
Detect Q&A by cues like “We’ll now open the line for questions,” names of analysts, or operator hand-offs.
Extract: capacity constraints, demand softness, churn, pricing pressure, pushouts, supply chain, competitive losses, product delays, quality incidents, salesforce turnover, AI/tech disruption, customer concentration.
Report management vs. analyst framing, evidence of walk-backs from prior guidance, and new risk disclosures.
3) Earnings Revisions
Scan: consensus downgrades, guide-downs, withdrawn guidance, negative pre-announcements.
Explain drivers: end-market weakness, mix shifts, GM compression, Opex creep, FX, working capital stress, customer deferrals.
Quantify: NTM revenue/EPS delta over lookback; direction, magnitude, timing.
4) Credit Risks & Liquidity
Check: interest coverage (EBIT/Interest), FCF/Net debt, short-term debt walls, covenant headroom (leverage, interest cover, liquidity), securitization reliance, customer prepayment obligations, factoring/receivables sales.
Watch: variable-rate exposure vs. rate path; undrawn RCF conditions; rating outlook changes.
5) Management & Personnel
Signals: abrupt C-suite turnover, CFO churn, departures tied to investigations, headcount cuts beyond restructuring narrative, Glassdoor / employee review inflections (if available), attrition spikes, HR/legal complaints.
Cross-link to performance periods and strategic pivots.
6) Shareholding & Equity Structure
Assess:
• SBC intensity: SBC/Revenue and SBC/CFO; persistent high levels diluting owners.
• Net share issuance vs. buybacks; repeated equity raises to fund operations or M&A.
• Insider behavior: broad-based employee selling, 10b5-1 patterns, concentrated insider disposals around events.
• Ownership concentration and governance control (dual-class, staggered board) that may entrench management.
7) Litigation & Regulation
Capture: active lawsuits (securities, IP, product liability, antitrust, labor), expected damages or settlement ranges; regulatory probes, consent decrees, sector rule changes (safety, data, privacy, AML/CTF, environmental).
Explain: how outcomes could alter unit economics, TAM, or capital needs; timing of milestones.
8) Other Operational/Financial/Counterparty Risks
Look for: customer concentration >10%, key supplier dependency, warranty/quality spikes, cyber incidents, data breaches, ESG controversies affecting permits or customers, off-balance sheet exposures (leases, SPVs), tax authority disputes, FX/commodity mismatch, geopolitical exposure, going-concern language.
9) Additional Red Flags (Analyst Discretion)
Anything outside the above that could impair cash flow durability, force capital raises, or compress valuation multiples.
Methods & Heuristics (apply consistently)
• Triangulate numbers across income statement, cash flow, and notes. Reconcile NI ↔ CFO ↔ FCF.
• Trend deltas: Compute YoY and sequential changes for DSO/DPO/DIO, contract assets, deferred revenue, inventory obsolescence reserves.
• Common thresholds (indicative, not absolute):
o CFO/NI < 0.8 for ≥2 years, or FCF negative while NI positive → Medium/High concern.
o DSO growth > revenue growth by >10–15pp for ≥2 quarters → Medium.
o SBC/Revenue > 10% for mature software; >20% for growth stage without deceleration → Medium/High.
o Net leverage > 3× with negative FCF; interest cover < 3× → High.
o Customer > 20% of sales or top-3 > 50% → Medium/High depending on contracts/tenure.
• Corroborate social claims with filings/transcripts before inclusion.
• Date all facts; prefer the most recent datapoint for the conclusion.
Scoring & Materiality
For each finding assign:
• Severity: Low / Medium / High (impact on EPS/FCF multiple or solvency).
• Timing: Near-term (≤12m) / Mid-term (12–24m) / Long-dated.
• Confidence: Low / Medium / High (based on source quality & corroboration).
Sum up with a category heat rating: 🟢 Low | 🟠 Medium | 🔴 High.
Required Deliverables (in order)
1. Executive Snapshot (bulleted, ≤8 bullets): the 20% of issues that drive 80% of downside risk.
2. Category Sections (1–9 as above): each with Findings → Evidence → Why it matters → Materiality. If none, say “No notable evidence surfaced in research.”
3. Revisions Table: timeline of guidance/consensus changes with drivers and links.
4. Liquidity & Debt Ladder: maturities, covenants, coverage metrics, and commentary.
5. Insider/SBC & Dilution Table: SBC intensity, net share issuance, notable insider transactions.
6. Summary Heatmap: category vs. severity (🟢/🟠/🔴).
7. Overall Conclusion (1–3 paragraphs):
o Presence/absence of red flags, their mechanisms (how they hit cash flow, multiple, or solvency), and materiality.
o Link to established theory: e.g., accrual anomaly (low earnings quality predicts underperformance), limits to arbitrage (risks persist despite awareness), credit cycle transmission to equities, dilution vs. per-share value.
o What to monitor next (leading indicators, dates/milestones) and decision implication (position sizing, hurdle for upside case, catalysts required).
Style & Quality Bar
• Citations after every finding (Publisher – Title – Date).
• No speculation without clear labeling and probability language.
• Prefer concise bullets, not prose walls.
• De-duplicate and cross-reference; avoid double counting.
• If data are insufficient, say so and state what would change your view.
Fallbacks & Edge Cases
• If multiple conflicting sources exist, present both views, assess evidence, and assign Confidence accordingly.
• If a category has legacy issues but no longer material, mark “Resolved/immaterial as of <date>” with evidence.
• If filings are stale but social chatter is active, do not upgrade severity without corroboration.
________________________________________
Template (paste this below your inputs)
Executive Snapshot
• …
1) Accounting Issues
• Finding:
Evidence:
Why it matters:
Materiality: Low / Medium / High
(Repeat bullets as needed; write “No notable evidence surfaced in research” if none.)
2) Transcripts: Growth-Affecting Issues
• Finding:
Evidence (quotes + date):
Why it matters:
Materiality: Low / Medium / High
3) Earnings Revisions
• Event / Date:
Direction & magnitude:
Driver:
Source:
4) Credit Risks & Liquidity
• Metric / Covenant / Maturity:
Observation:
Headroom / Coverage:
Materiality:
5) Management & Personnel
• …
6) Shareholding & Equity Structure
• …
7) Litigation & Regulation
• …
8) Other Operational/Financial/Counterparty Risks
• …
9) Additional Red Flags
• …
Summary Heatmap
Category Severity
Accounting 🟢/🟠/🔴
Transcripts …
Revisions …
Credit/Liquidity …
Management …
Equity/Dilution …
Legal/Reg …
Other …
Additional …
Overall Conclusion
• Do red flags rise to thesis-changing? Why?
• Transmission channels: (earnings quality → multiple; liquidity → survival risk; dilution → per-share economics).
• Theory links: accrual anomaly; credit cycle impacts; governance and valuation discounts.
• Monitors & milestones: dates, KPIs, disclosure events.
• Decision guidance: sizing, risk controls, catalysts required to negate flagged risks.