Five Red Flags to Spot When Investing in Stocks – Introduction
Investing in stocks has stocks has made people billions, if not trillions. People like Warren Buffet, Dan Loeb, and David Einhorn have made billions investing and trading in stocks. As a trader, there are a number of red flags that you should always look at when investing in stocks. In this article, I will highlight some of these red flags.
First, you should always look at a company’s debt and its credit rating. Ideally, you don’t want to invest in a company that will soon be bankrupt. You want a company that will thrive and one that does not face any risk going forward. A good example is a company called Valeant whose share price has fallen from $250 to $9 within a few years. Although the company generates good cash, the fact is that it has $31 billion in debt. Its total assets are worth less than that. Therefore, chances are that the company will go bankrupt. As an investor, you should not invest in such a company for the long term. However, as a trader, it is acceptable to trade in the company because you are not interested in its intrinsic value.
- Dividend Yield
Many investors are attracted to high-dividend yield companies. They are interested in making a return on their investment through share appreciation and high dividend. Unfortunately, most companies with high dividends are usually not the best. The reason they reward their shareholders heavily is to protect their share price. At some point, this will go burst. If a company has a high dividend yield, you should look deeper. You should look at its payout ratio. If the ratio is below 100 and going down, this is a company you can invest in. If on the other hand the yield is negative or above 100, you should avoid the company.
- Falling revenue
The reason you invest in companies is to realize growth. You want to invest in a company whose revenues and EPS are growing. If you invest in a company whose revenues are shrinking, chances are that you will not realize your investment. Therefore, you should invest in a company that is growing revenues and one that has issued a positive guidance.
- Insiders selling
Before you buy shares of a company, you should look at the recent insider transactions. In this, you should look at what the insiders are doing. If the insiders are buying the shares of the company, chances are high that they are confident in the company. However, if they are selling, it could be a sign that they are not confident. Therefore, you should take time to look at what the insiders are doing. It could be a signal to buy or sell a company.
- Management exits
Management exits are a sign that a company is not doing well. Normally, managers will like staying in a company that is stable. They will not want to leave a company that has great prospects. Therefore, when you see many managers leaving, it could be a sign that all is not well. You should look at the reasons why the managers are leaving the company. A good example is Twitter whose stock has underperformed since its IPO. Recently, the company’s managers have left and its original shareholders sold their stock. This is a sign that things are not good in the company.