New to Investing in 2024? Avoid Stocks with These 3 Red Flags

So, you have some money and want to invest it in the stock market?

That's great. The stock market is a wonderful place to create long-term wealth. Once you understand what the market is all about and how it works, you have taken your first step to growing your wealth.

But that's just the beginning I'm afraid. There's much more to it. You see, if making money in stocks was easy, everyone would be doing it and the world would be filled with millionaires.

Of course, that's not the case. Profiting from the stock market takes time and knowledge that comes only from experience.

Fast profits are possible of course but then you would be dependent on luck and the tide of the overall market. If you get unlucky or if the tide of the market turns downward, you will lose money.

This is why you may have heard negative things like the stock market is the best place to easily lose money or something on those lines.

Thankfully this kind of ignorance has abated in recent times. Most of the investing public, not just in the big cities, have come to trust the Indian stock market. This is evident in the rising retail investor participation. And that's a very positive thing.

However, this isn't enough. Apart from the basics, you also need to know how to not lose money. This is the most important skill in the market and it's difficult for new investors to grasp. After all, new investors are excited about making money and don't think too much about avoiding losses.

So, if you are new to this and have many questions about how to invest in the share market, then you're reading the right article.

You see, more important than finding the right investing strategy or the next hot stock, is to avoid mistakes. As Tanushree Banerjee, our co-head of research, likes to remind investors, "To finish first, you have to first finish."

That means not losing money. The more of your capital you lose, the harder it becomes to create wealth because you need to earn back your losses too.

So how do you avoid losses in the stock market?

We have made a short 3-point checklist to guide you in spotting red flags to avoid.

#1 Avoid Loss Making Companies

We understand the appeal of these stocks. If a company has been making losses for some time, it's likely that most investors have given up on it and the stock has crashed.

This means if the company were to turnaround and get back to its profitable ways, then the stock would turn into a multibagger. Thus, investors who get in before this happens will win big.

Unfortunately, this is not investing. This is speculation. And dangerous speculation too. There is no guarantee the company will turn around. If it doesn't, you are putting your hard-earned money at risk.

As a new investor, it's best to avoid these so-called turnaround stocks. A good way to do this is to avoid stocks of all loss-making companies. Consider only profitable companies.

#2 Avoid Companies with High Debt

Companies with high debt should raise a red flag as far as we are concerned. Shares of these companies are high risk.

If sales were to slowdown, the net profit will take a double blow because the interest payments will remain the same. The management will have to prove that the business scan not only pay down the debt but can also grow profits.

Thus, the market looks at companies with high debt, sceptically. Companies with high debt can be easily identified by the debt to equity ratio.

As a new investor, it's best to avoid companies with a debt to equity ratio is higher than 1. Conservative investors can use an upper limit cut-off of 0.5 for the debt to equity ratio.

Now the term 'high debt' is subjective. For example, large companies can take on more debt than smaller companies.

A high level of debt alone cannot define the company's ability to service it, which is an indelible feature of an indebted company. This is why you need to look at things like the company's cash flow and capital expenditure needs.

Therefore, a better way to identify the risk is to check the interest coverage ratio. The interest coverage ratio measures the ease with which a company can pay back the interest due on its total debt. The higher the better.

#3 Problems with the Management

At the end of the day, all businesses are run by people. It's people who make all the decisions, not the plant or machinery.

The management can either make or break a company, especially small ones. Large companies may have procedures and protocols that will keep the business running in spite of multiple bad decisions. But small companies will feel the heat of even a few bad decisions.

Investors should be especially wary of managements with a shady reputation. It's best to avoid such stocks even if the story being sold is tempting.

Remember, when it comes to the management, it's better to be safe rather than sorry.

Conclusion

These are the top 3 points to watch out for as a new investor.

If you avoid these red flags, we believe you are well on your way to achieving your investing goals.

Once you have learnt to safeguard your wealth, you can then focus on growing it. Always remember that return of capital is more important that return on capital.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...