5 Warning Signs You May Be Buying a Stock That’s Too Cheap
If you’ve ever been tempted to buy a stock because its price is high and it’s on social media and in the news, you’re not alone.
But while some of these high-profile stocks may be great additions to your portfolio, others lack the fundamentals to perform well over the long term, and can lead to big losses for investors who buy high.
You don’t need to search for the next big thing. Diversifying into high-quality, dividend-paying companies and investing in broader markets instead helps reduce your risk. Here are five red flags that can help you decide if you’re buying an overstocked stock.
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1. Bad foundations
No matter how popular a stock is, if a company does not have strong fundamentals, there is a good chance that its price will not continue to rise over time. Some common metrics used to evaluate a stock’s fundamentals are cash flow, earnings per share (EPS), price-to-earnings ratio and dividend yield.
Keep in mind that it’s possible for a company to be unprofitable for several years after going public, eventually reporting its first profit and generating impressive long-term returns. And remember that picking stocks that will go up based on these kinds of metrics is a challenge even for experts on Wall Street.
2. Social media driven buzz
There must be more to a stock’s long-term performance than what the CEO posts on social media. While executives posting about their companies can generate more attention for businesses that bring in high revenue and revenue growth, those same companies can be overrated.
Many people post about their favorite stocks on social media, too. But be careful not to invest in a company just because you see it mentioned a lot on the internet.
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3. Excessive debt burden
Pooling huge financial power is helping many people retire early, but that same power can hurt indebted companies. It’s a challenge to turn a ship around when interest costs make up a large portion of a company’s overall costs. These companies can end up paying higher interest rates, reducing their ability to invest in employees and research and development.
4. Focus on the sector
Another big warning sign might be prioritizing one hot sector right now instead of diversifying your portfolio. While some investors make amazing returns with this strategy, you can lose a lot of money in luxury sectors if you don’t pay attention to your asset allocation.
Diversifying into broad market index funds in addition to holding sector-specific funds can help reduce potential risk.
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5. Non-moat company
Wall Street experts often look for companies that have unique advantages over competitors. Walmart, for example, has more than 10,000 locations and offers low prices on a variety of products, while Nvidia has developed chips that help power many of the artificial intelligence innovations we see today. Those are the main channels of competition. If a company is getting a lot of attention but has no competitive edge, it may mean that it is not ready to generate strong returns in the long term.
