4 Red Flag Warnings of a Bad Stock Investment

When looking to buy a company that you want to add to your portfolio, there are several things to look for. There are also several things to beware.

I believe that any of the following red flags — signs of a bad stock investment — are sufficient cause to pass on a specific company. 

Major debt

A large amount of debt is not a good thing. When a company has too much debt, especially long-term debt, that company is more than likely in above its head and could potentially never recover. 

This can be defined as debt equaling more than a couple of years of free cash flow (FCF).

When a company is experiencing this kind of debt, they can use it as an excuse to file for bankruptcy, which means investors lose everything while the company gets to restructure. 

Bad management

This can be determined by looking at return on invested capital (ROIC).

If they have a good ROIC, that means they are using the money they are being lent wisely. This usually indicates that management is interested in looking out for their investors and  not just their own interests. 

ROIC should be at least 15%. Anything above that is even better. 

If ROIC has been declining over time, that is usually a bad sign and you should beware investing your money in this company. 

No moat

A “moat” is when a company has a durable competitive advantage over the other companies in its respective sector. Without a moat, other companies will be able to come in and steal market share or even wipe a company out completely.

Famously, Warren Buffett refers to Coca-Cola having a moat in its branding. “It’s the real thing” and so forth. Cola is just sugar water, yet Coke is known worldwide. The same thing could be said for Nike athletic shoes or Starbucks coffee. Shoes and coffee are commodity goods. Branding makes the difference and creates a protective moat. 

No moat means no guarantee a company is a safe investment. Also, having a strong moat will help a company stay viable and strong during a recession or any kind of event that could potentially affect the stock market as a whole. 

Complexity

Always try and buy companies that are easy to understand. It will make it much easier for you to evaluate and understand in the long-run if it’s an easy to understand company. 

For example, it is probably much easier for most people to understand burritos than vaccines or microchips. 

That is why I would invest in a company such as Chipotle (CMG) before a company like Moderna (MRNA) or Advanced Micro Devices (AMD).

Maybe you understand vaccines or microchips. If so, invest as you see fit. But most investors don’t. Stick with what you know and it’s hard to go wrong.

Recommended Articles

6 Exotic Vacation Spots Where a Dollar Goes Farthest

The average cost for an American to go on vacation is just about $1,200. Depending on where you go, that cost might barely cover the airfare. That’s the thing about

4 Safe Ways to Earn Steady Retirement Income

Retirement should be a time to relax and experience the good things of life that you probably missed when you were working full-time. However, to have a truly good time

Restless Leg Syndrome — Is It All in Your Head?

If you’ve ever felt tingling, crawling or tugging sensations in your legs, seemingly for no reason at all, you might have thought you were going crazy. These feelings may keep

11 Money-Burning Impulse Buys You Must Resist

The average American spends over $5,400 every year on unnecessary impulse buys. Think about what you could do with an extra $5,400. Setting aside that amount in a retirement plan

5 Questions to Ask Before You Take Money from a 401(k)

Sometimes even the most financially prudent individuals may go through an unforeseen emergency that forces them to consider making an early retirement withdrawal. However, while in your moment of difficulty

10 Ways to Spend and Live Well With No Cash

Living a healthy lifestyle isn’t always easy, and it can weigh heavily on the wallet. Organic food can cost a pretty penny and holistic healthcare models are often paid out

Save Hundreds by Being Your Own Pest Control Service

The average cost of a pest control visit can be anywhere between $150 to about $1,500, depending on the severity of the problem. Most new homeowners don’t appreciate that when

How to Protect Your 401(k) in the Event of a Market Crash

It's normal for investors, especially those close to retirement age, to worry about fluctuations in the market and how it will affect their 401(k) plans. And while there's no way

Would You Eat Ugly Carrots to Save Money?

“Ugly produce” a is term for aesthetically unpleasing food that usually goes unsold in lieu of more cosmetically appetizing fruits and vegetables. Bruised, blemished, or misshapen apples, double-headed carrots, or

credit score boost

Credit Score Boost: How Your Behavior Affects Your Credit

A credit score is a lot like your personal economic statement. Getting a credit score boost improves your money life immediately. Any time you apply for a loan, a mortgage,

Retiring? Here’s 4 Cities Where You Can Live on $1,500 Monthly

Retirement should technically be a wondrous time of life where you stop living to work and start working on living. However, retirement in real life is nothing like the pop-culture

8 Things to Do the Moment You Start Feeling Sick

Some days, you just know something’s got you. When you feel that heaviness in your head, an aching in your joints or scratching in the back of your throat, it’s