Red Flags To Watch Out For When Choosing Stocks (2)

One of the easiest ways to have a bad investment journey is to invest in the wrong stocks or add faulty stocks to your investment portfolio. This is why there are stock picking strategies.

However, as highlighted in our last post, one of the easiest ways to figure out if a stock is good or bad is to watch out for the red flags and warning signs. The following are more red flags to be on the lookout for:

Companies that are under investigation

A sign that a company’s stocks should be avoided is when the company is under investigation especially when it is related to fraud and misappropriation. It is possible that existing shareholders who suspect that the company hasn’t been very open with them, cab commence investigations into the affairs of management even beyond audit.

It is also possible that the company might have been involved in a case that is tied to an individual with a criminal case whose that can negatively impact share prices. The company might have been sued for illegal actions as well. For these reasons, where a company is under scrutiny, it is important to take caution and watch first before proceeding.

Companies that are heavily leveraged

If the balance sheet of the company is majorly financed by debt, it might also be a red flag to watch out for. Stocks with a good balance of equity and debt are the best kinds. If the company has gone out of its way to borrow to keep itself standing, it means not many investors are willing to finance it and there could be a reason why.

Also, with the rising interest rates, the company might be walking into a trap it may not recover from. With financial institutions, the reverse is the case. A good example of this are banks that have a huge portion of non-performing loans.

A non-performing loan is a loan that is in default or close to being in default. Loans are tagged as non-performing when there has been default for a stipulated period based on the terms of the agreement. This too can be a red flag to watch out for.

Stocks with unstable dividend history

You don’t need to be focused on dividends as opposed to growth in value of the company to see this as a red flag to be wary of. The usual idea is that a company that pays dividends frequently would grow at a slow pace (also because it could pay good dividends as a compensation to shareholders for its slow growth) and a company that is focused on growing would use most of its gains to reinvest and expand so as to grow.

However, where a company is neither here nor there, you need to watch out. Unstable dividend history could mean its strategy is not defined. It could also mean the company might be facing internal challenges that might affect its sustainability.

After running your potential stock investment through these tests, you should know if it is still a good idea to invest in it or not.

Written by Lawretta Egba.