Motley Fool Australia

5 red flags to look out for when investing in the share market

Creating wealth through investing is a lifelong endeavour and over a lifetime of investing, you are bound to make mistakes.

Yesterday alone, a few ASX listed companies experienced significant drops including:

  • The Kogan.com Ltd (ASX: KGN) share price – down 33%
  • The BWX Ltd (ASX: BWX) share price – down 16%
  • The Livetiles Ltd (ASX: LVT) share price – down 16%
  • The Redbubble Ltd (ASX: RBL) share price – down 12%

Whilst these drops aren’t by any stretch of the imagination the worst that could happen, they can sometimes leave investors reflecting on whether they made a mistake.

One way of minimising mistakes is to identify red flags early. Here are 5 red flags to look out for when investing:

  1. Beware of insider selling. Company insiders, particularly the key decision makers, tend to know their business better than anyone else. When they start to sell significant portions of their shares in the company, it could be an indicator that they no longer see much upside in owning the company’s shares.
  2. Beware of companies with contracting gross margins. When margins start to contract, it could be an indicator that the company is being forced to lower its prices in order to remain competitive or that its production costs are increasing but it is unable to pass them on to the customer.
  3. Beware of regulatory changes. Some businesses rely on regulatory loopholes and when changes in laws occur, it can destroy a lot of shareholder wealth.
  4. Beware of companies that rely on a few large customers. Losing those customers could have disastrous consequences.
  5. Beware of companies with a bad culture / unhappy staff. A workforce that is disengaged is unproductive but they still get paid which is a double whammy for shareholders.

Foolish Takeaway

The importance of looking out for red flags cannot be overstated. Whilst the red flags I have identified are certainly worth looking out for, it’s also important to remember that no one has a 100% strike rate in investing and so you will make mistakes from time to time.

The good news is that when great companies do well, they can outperform the losers in your portfolio.

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Motley Fool contributor Kevin Gandiya has no position in any of the stocks mentioned.

You can find Kevin on Twitter @KevinGandiya.

The Motley Fool Australia owns shares of and has recommended BWX Limited. The Motley Fool Australia owns shares of REDBUBBLE FPO. The Motley Fool Australia has recommended Kogan.com ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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