Topic: How To Invest

Investor Toolkit: These subtle hints can tell you if one of your stock market picks is headed for disaster

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on the fundamentals of successful investing and how to make better stock market picks. Each Investor Toolkit update gives you a new fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “Stay alert for subtle risk factors, because they may appear long before disaster strikes.”

Most investors are aware of standard investment risk factors, such as disappearing profits, cuts in dividends, police investigations, etc. But it pays to be aware of more subtle signs of coming problems:

  • The edifice complex: When companies pay to name buildings after themselves, or build excessively costly head offices, it may mean they are pursuing prestige at the expense of profit.
  • The squawk indicator: When outsiders criticize a company’s accounting and the criticism is unjustified, most corporate insiders simply ignore it. But if insiders have something to hide, they may squawk loudly — that is, threaten to sue critics of their accounting practices, in hopes of shutting them up.

    It mostly pays to stay out of companies that attract accounting criticism, but all the more so when insiders react with outrage and lawsuit threats. You probably won’t miss much profit by staying out, but you’ll avoid some of the market’s worst disasters.

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  • The middle-age-crazy syndrome: Many public companies are run by middle-aged males who reached these high-paid positions by working hard, marrying young and generally putting career ahead of their family and personal lives.

    In mid-life, all too many are overwhelmed by a desire to make up for fun they’ve missed. Some go on to achieve a healthy balance in their lives, possibly following a divorce and remarriage. Others divorce themselves from business reality. They take on foolish business risks, at great cost to themselves and their shareholders.

    Hypothetical example: If the chief executive of, say, a gravel pit, announces that the company is going into feature film production, you have to wonder if he has uncovered some great new secret of making money in films, or if he simply wants a socially acceptable way of meeting actresses.

Successful investors stay alert for hints of troubles in their stock market picks. By the time dividends and earnings disappear (or the police arrive), it may be too late to get out without a big loss.

Next Wednesday, June 16, 2010, Investor Toolkit will show you how to read between the lines of a corporate earnings statement.

You can get our latest updates on issues that affect your investments, plus buy/sell/hold advice on stock market picks you may be considering buying (or selling), in our Successful Investor newsletter. Click here to learn how you can get one month free when you subscribe today.