In this post, I’ll give you the top five red flags to avoid when researching long-term investment opportunities.
Hello everyone and welcome back to Investing with Antoaneta. In today’s installment, I’ll give you the five major “red flags” that you need to be aware of when researching companies to invest in. Because let’s be real – not every company that you “like” is going to be a good investment target.
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Before investment here are five things that you need to look out for:
- Companies that don’t have a Moat
- Companies with a bad management team
- Companies with a ton of debt.
- Companies that you don’t understand
- Companies that have fierce competitors
Today, I even have a bonus tip that you can apply to things outside of investing as well. Stick with me until the end, and you’ll see for yourself!
Investing Red Flags #1 – Moats (and lack thereof)
If a business wants to be successful and overcome its competition, it needs a unique advantage. Something that sets them apart from everyone else in the field. Something which ensures that the customers will go to them and stay with them.
As a huge fan of Warren Buffet (and a business leader myself), I always look for companies that have durable competitive moats. I went over this factor in-depth during my investing course The Warren Buffett Way, which you can check out by following the link in the description below. But let’s keep things short and sweet here.
- All successful companies have a durable competitive moat.
- Durable Competitive Moats bring safety in the long-term.
- They also help companies live through inflation, bad economic periods, and recessions.
Investing Red Flags #2 – Bad Management
Management teams are a big deal. If you have participated in any of my webinars or signed up for my investing courses, you know that I like to talk about the importance of good business management a lot. Yes, this is partly because I am a business leader myself, and because I have seen the value that good management brings to a company. But it’s also super-important from an investing perspective.
A great management team and a good CEO can take an average company and turn it into the next huge thing. A bad management team, on the other hand, can take a great company and run it into the ground (especially if the board doesn’t take measures in time).
So, how do you tell if the management is good? There are plenty of ways to evaluate a management team, but the easiest (and most reliable) approach is to just look at the stats. I mean, that’s what they are there for, right?
Take a look at the Return on Invested Capital (or Return on Assets). This statistic tells you how well the management can leverage the money they have. If the business that you’re researching shows good returns, it means that the management is capable. You’re looking for about 15% in this category.
Also, remember how I said that we care about the long-term and the future? That means we want to invest in companies where the return on invested capital is trending up. If it’s going up, things are likely improving. If it’s going down, well … you’ve got your red flag right there.
Investing Red Flags #3 – Tons of debt
Then, comes the debt. And, if you think about it, it’s kind of obvious – nobody likes debt, right? Why would you give your money, your hard-earned cash, to a company that’s loaded with debt? Big debt can be very detrimental to a company. In the long term, it can very quickly kill it off. And, since we are all long-term investors here, we care about the future of our investments. We want to give our money to businesses that have a bright future ahead of them.
Of course, a considerable portion of the companies out there does have debt, because it’s just how things work. I’m not telling you to avoid every single business that has a bit of debt since that would cancel out more than 90% of companies. Instead, you want to compare the debt to cash flow.
Cashflow vs Debt – If you are researching a company and you see that they have debt equal or greater than multiple years’ worth of Cashflow, then you’ve got yourself a red flag.
Then, there’s also the potential for bankruptcy. If a company has racked up a lot of debt, the management team can use it as an excuse for bankruptcy. Sadly, this happens more often than not, especially if the management team is … less than excellent.
Investing Red Flags #4 – Companies that you don’t understand
Well, this one isn’t exactly the fault of the company, but it’s still something that you absolutely have to avoid. And I can’t stress this one enough, guys – never, ever put your money into something you don’t understand.
Before investing in a company, make sure that you:
- Understand the field
- Understand where the money comes from
- Understand where the money goes to
- Understand the dangers and possible problems
- Understand the prospects for the future
This is a big trap, especially for beginners. They see good stats, they see promise, and they just jump right in. And yes, this might work in the short-term.
But here’s the thing – we’re long-term investors here. If we don’t understand the field and the business, we can’t see a clear picture of the future. And since we’re usually looking to buy and hold stocks for more than a year, we NEED to be able to judge where the company is going to be. Think about one year into the future, then – three, five, or even ten years from now.
Investing Red Flags #5 – Companies that have fierce competitors
If the company is faced with a lot of well-established competitors, offering high-quality products or services, they might have a hard time holding up, moat, or no moat. This is why most beginner investors prefer to stick with the well-established leaders in a given field, instead of betting on the underdogs. While you’re still new, I suggest that you do the same, because it’s much safer. Wait until you have at least a couple of years of experience under your belt before you branch off, looking at the smaller budding businesses.
Investing Red Flags #6 – Bonus Tip
For today’s bonus tip, I’ll leave you with a proverb that can be applied not just to investment, but also to business and life in general:
If it seems too good to be true, it probably is NOT TRUE.
And I feel like this is really important right now because with all the COVID-19 stuff and the economy being in the weird state that it is, people are very impatient. They tend to jump into things without thinking, and they are very likely to fall for the hype and other marketing tricks.
No matter how hyped a stock is, you should:
- Always remain calm.
- Always do your research.
- Always check for red flags.
- Always think before you buy it.
- Never buy something just because “this other person or big name” is buying it.
- Never invest in things that you don’t understand.
And with this, we reached the end of this post and I’m very happy that you were with me here today and I hope that you learned something useful. As always, please make sure to give me a thumbs up if you enjoyed this content and don’t forget to share it with your friends and family.
If you have more questions about investment, or if you’ve got some red flags of your own to share, please don’t be shy and let me know in the comments section below – I always love hearing from you.
You can also get in touch with me by email at [email], or on Social Media – [SMM links]
Thank you all for reading, and until next time:
Stay green and motivated!
Suggested Further Reading:
More about Investing:
- Practical Investing Advice – Read this before you start investing
- Learning how to make wise investments – 7 ways to go – General Investing tips (suitable for beginners and veterans)
- Reasons to invest in your future. Understanding the importance of pensions and savings – Investing tends to … cost money. Set up your budget and ensure that you’ve got enough funds.
- 8 Goals That Will Help Improve Your Life In 2020 – How financial independence helps you in all areas of life
Minimalism and Healthy Living:
- My approach to minimalism in 15 steps – How minimalism can help you save money
- How to live a minimalist life – How to lead a minimalist life, save money and protect your health, all at the same time
Courses & Webinars
- Basic Steps in Stock Market Investment – Kick-start your investing career today
© Lifestyle Tips by Antoaneta
Recommended books for further reading:
- Think and Grow Rich
- Rich Dad, Poor Dad
- The Richest Man in Babylon
- Cash Flow Quadrant
- The Science of Getting Rich