7 Signs of a Bad Investment
November 19, 2011
Finding a good place to invest your money isn’t always easy but a good way to start is to weed out the bad investments. Obviously this won’t end up with a list of the best places to put your money, but narrowing down your choices to help avoid the worst is a good place to start. Here are 7 warning signs to look for that will help you recognize and avoid bad investments.
1. Balance Sheet Problems
One of the first courses I took when I got my Masters Degree years ago was Financial Accounting, it turned out to be one of the best classes I’d ever taken. Not that the instructor was that great but I loved learning about how to read financial statements (balance sheets, income statements, cash flow statements) and all the ratios you could use to analyze the financial health of a company.
Here’s a good overview of how to read a balance sheet. While nearly every company is going to do a certain amount of borrowing, it is important to make sure that the growth of debt isn’t outpacing the growth of assets. Also, look for evidence that cash is getting rather scarce. Also, keep in mind not to put your full faith in a company’s financial statements. Just use this as one measure of researching an investment.
2. Bungling Management
While the company might be doing okay, does managerial incompetence pose a major risk? Look at how management runs the company, especially if there has been a shake up. If you think that the change is for the better, then consider investing. However, if the change appears for the worse, pass on it. And, of course, if things have been getting steadily worse, even without a shake up, it could be a sign that management is ill-equipped to deal what’s going on right now.
3. Lagging Behind in the Industry
Another consideration is where the company stands with regard to other companies in its industry. Find out why the company is lagging. If management, research, product, or some other item appears to be responsible for industry lag, you might be in trouble if you invest in that company.
4. High P/E Ratio
When a company has a high price to earnings ratio (P/E), it means that investors are paying more in relation to each unit of net income. If a company has a high P/E ratio, especially compared to its peers, it could be a sign that it is overvalued, and that you might consider staying away.
5. It’s “Hot” Right Now
It may seem strange to think that a “hot” stock (or other investment) might be a bad idea. However, the fact of the matter is this: If something is “hot” right now, you are likely too late to get it at a good price. In fact, the fact that something is exploding right now could be a sign of a bubble, and that it could be on the edge of bursting. You don’t want to get stuck with a burst investment bubble just as you buy something at a peak price.
6. You’re Getting an “Inside Tip”
Whether the “inside tip” comes from an email, from your brother, or from a co-worker, anytime you are offered the “inside track” on some investment, it is usually a red flag. Sometimes “insider” tips are used to help pump up a stock price so that someone else can dump it when it gets to a higher price. The worst part is that, if you are getting your “tip” from a family member or friend, they are probably being duped as well. Be wary of such “inside” information.
7. You Only Have a Limited Time to Get In
Good, solid investment choices are usually going to be around next week. Beware the amazing investment opportunity that your buddy has brought up that requires you to come up with a large amount of capital within a day or two.
A good investment should be a good investment next month, and you can generally buy partial shares through a low-cost, online brokerage. Anytime someone is pressuring you to go in, with a great deal of capital, right now, that’s a sign to run the other way.
What are some of the signs you look for help you know not to invest your money?
All posts by Ben Edwards