4 Signs You Shouldn’t Invest in a Company

When it comes to investing, you have to do more than review a blogger’s “best of” list and follow their suggestions. Successful investing requires a disciplined commitment to thorough research and firsthand evaluation. Before making any investment – in a private or public business – there needs to be a prolonged period of due diligence. Only then can you make an educated investment.  

Evaluating a Company’s Warts and Blemishes

When doing your due diligence on a business, it’s easy to get caught up in all of the sexy attributes of the company. After all, you want to convince yourself that there’s an investment opportunity with the chance of a high return. But be wary of taking a jovial, opportunistic approach. Instead, you’re far better off being critical and slightly pessimistic. It’s less enjoyable on the front end, but will produce better returns on the back end.

When evaluating companies to invest in – whether in the form of stock ownership or an equity investment – keep your eyes peeled for the telltale signs of trouble. The following warts and blemishes can be particularly problematic:

1. Lawsuits and History of Product Defects

We live in a litigious society where companies that don’t follow the rules get slapped around by damaging accusations and costly lawsuits – and rightly so! Businesses are responsible for the health and safety of their paying customers. Should they provide products that malfunction and/or cause damage, consequences ensue.

“In many cases, manufacturers cause injury when they try to save money by using inferior materials, cheaper production methods or other shortcuts,” Ward & Barnes, P.A. explains. â€œThey can also cause injury when they fail to fully and adequately warn of the known risks associated with the use of their products.”

Stay away from companies that have a history of product defects and related lawsuits. This reveals a track record of irresponsibility that could jeopardize the company’s full potential.

2. Dwindling Cash

While debt is a useful instrument, cash is king in the business world. Companies that burn through their cash quarter after quarter should be viewed with skepticism.

When evaluating potential investments, be sure to review balance sheets and cash flow statements to see how much cash is being spent (as well as how much remains). Of particular interest is the comparison of cash flow and cash holdings with the same period during the previous year. This will provide a big-picture view of the company’s direction over the past 12 months.
3. Stock Performance > Company Performance

For publicly traded companies, be wary of getting caught up in the hype of rising stock prices. If stock performance outpaces company performance (i.e. revenue, cash flow, profitability, growth, etc.), then a correction is inevitable. Ideally, you don’t want this correction to come at your expense. You’re better off investing in companies that are currently outperforming their stock prices.

4. Everyone Else is Doing It

You tell your kids not to do something simply because everyone else is – yet you’re tempted to do the same with your investments. Why?

“Following the herd when it comes to investing is a big no-no,” investment advisor John Csiszar writes. “Sure, panic buying sometimes creates a frenzy akin to the Dutch tulip craze of the early 1600s. However, just like that bubble popped, ‘hot’ stocks and markets often crash when the excitement passes and everyone heads for the exit at once.”

Avoid investing in a particular company simply because everyone else is. The best investments are the ones that satisfy your investment criteria, yet don’t have all the hoopla that other companies are receiving in the press.

Patience and Wise Investing

Investing success isn’t something that can be synthesized in a beaker and turned into a scientific formula or mathematical equation. There are far too many independent variables for that. But if you dig deep and evaluate some of the more significant elements, you’ll notice that patience is among the most important factors in wise investing.

Whether you’re an experienced investor or an amateur who is delving into the waters for the first time, patience is something worth cultivating. Take your time and evaluate each the good and bad in each investment before ever forking over any money. You’ll save yourself from unnecessary risk and heartbreak.