We’ve all heard the investment horror stories, like when Steinhoff’s share price plummeted unexpectedly. But how does this happen, and is there a way to spot investment red flags before it’s too late? Here are some things to be mindful of when choosing companies to invest in.
Spotting Investment Red Flags
Before investing, here are a couple of things to look out for when looking for investment opportunities and companies to invest in.
1. No Cash Flow
Inadequate cash flow is one of the surest signs that a company in South Africa is not doing well. Poor cash flow tells you that the company is not managing its finances correctly. Think of your friends who seem to have all of the latest and greatest but are always broke. In that same way, you don’t want to invest in a company that’s barely making ends meet and using credit to pay for day-to-day expenses.
2. Expanding Too Quickly
Many companies in South Africa suddenly, and almost inexplicably, expand into offshore markets. These companies are often playing with fire and not grasping how badly it can burn. You will see it time and time again how companies branch out too soon and aggressively, only to return with a loss and lessons learned.
3. Overcomplicating Things
If a company has an overcomplicated corporate structure, it could be trying to hide financial malfeasance. This is often to distract from what’s really going on and makes it difficult to track and pinpoint where there’s trouble. You can often see this in overly complicated financial reporting, distracting from debt levels or inflated earnings.
4. Excessive Share Issuance/Growth
Shares are a costly way to get more capital. Therefore, if a company is issuing shares excessively, they could be trying to cover debts and consequently diluting existing investors’ holdings.
5. Everyone’s Talking About it
If it sounds too good to be true, it’s too good to be true, right? Well, if you feel like everyone is raving about it, you might want to delve a bit deeper before investing. Following the crowd and falling victim to peer pressure should not influence your investment decisions.
6. Keep Emotions Out of it
Try not to react with emotion, whether it’s fear of missing out or getting caught up in the hype, etc. Do your research, steer clear of confirmation bias, and make sure you have a long-term investment manager who approaches investments rationally.
7. Cross Shareholding
When there’s cross-shareholding and active trading in shares between subsidiary companies, it could lead to inflated asset values across related companies. This can cause the share prices to go up as there’s increased buying, but without any fundamental changes to the actual companies.
It’s human nature to get caught up in the moment and the latest and greatest investment opportunity. However, it’s important to get all the information before you decide to invest and keep an eye on any evolving circumstances within a company that raises one of these red flags.
It’s also always best to consult an independent financial adviser to guide you through your investment decisions with the most up-to-date information.