Playing Investment Defense

By Glenn Curtis AAA

Investors need to learn to play better defense. In other words, they need to learn to look out for things that can potentially have a serious and adverse impact on the company that they are invested in. For example; what should you ask? And where should you look? Read on for some simple tips.

Litigation
Is the company you own shares in engaged in serious litigation? If so, how serious is it? Could it have a material adverse impact on the company? In short, be sure to check out the 10K, 10Q, press releases and/or the proxy statement for additional details as they may be discussed there.

What if there is something you don't understand or something that you would like to learn about or need further clarification on? Consider calling the company's investor relations department and asking directly. That is what they are there for, to answer investor inquiries. (For more check out Who is responsible for protecting and managing shareholders' interests? and Where can I find a company's annual report and its SEC filings?)

Also, it might make sense to search the web for any news articles related to a particular suit. Such articles might detail the amount of money in dispute and maybe contain an idea of what the potential outcome might be if a judgment was reached in favor of the plaintiff.

Short On Cash?
A company can have an all-star management team, a beautiful facility and catchy marketing slogans, but a company without cash is kind of like a race-car without fuel. With that in mind, investors and would-be investors would be wise to research how much of the green stuff the company has on hand to fund ongoing operations, and to grow.

The balance sheet can be a great place to start. It will show the dollar amount of cash and equivalents and short-term investments as of a certain date. What does that equal per share? Is the amount consistent with what some of its competitors are carrying? Is it up or down sharply from the prior quarter and the comparable period the year before? In the Management Discussion & Analysis section of the quarterly report or 10K, does the management team comment about whether or not it thinks the amount is sufficient to fund operations and grow? (Learn about the components of the statement of financial position and how they relate to each other, see Reading The Balance Sheet.)

Remember, if a company needs to tap the equity markets in order to raise cash, dilution could become an issue.

Competitive Threats
It's sometimes easy to get caught up in a given company's story. In other words, if a company has been showing excellent sequential and year-over-year growth, has a great name and a great product or service, it's possible to become mesmerized in a way. But the investor or would-be investor should never get complacent.

Instead, investors should always do their homework; they might consider searching online for companies that make competitive offerings and review trade journals. Investors might also listen to company conference calls as management may sometimes comment on competitors. Reviewing the competition's websites might be another idea as well. Basically the idea is to try to get a handle on whether or not others are nipping at your company's heals and whether or not their product or service may change the dynamics of industry. (These events offer the average investor a chance to hear management respond to analysts' hard-hitting questions, read Conference Call Basics.)

Grasping new competitive threats early on in the game is obviously important, because it's possible that the market leader today could get knocked out of the box and be a second-tier player tomorrow.

Macro Threats
It's sometimes difficult and in some cases impossible to predict certain macro events in advance. In other words, predicting interest rates or the price of a gallon of fuel a year or two down the line can be difficult at best.

However, it is important to know that political unrest, economic crisis, weather or other factors can potentially cause a stock to drop. It's also important to try to understand how they might impact a company. Therefore, savvy investors should try to take note of all macro events and try to figure out their potential impact, if any, on the industry in which the company operates and the company itself. (Learn more in Macroeconomic Analysis.)

For example, if one Middle Eastern nation were to become engaged in a conflict with another, it stands to reason that there could be a disruption of the oil supply from the region. This, in turn, could have an adverse impact on supplies here and by extension force up the price of a gallon of gasoline. Taking this one step further, companies that truck a larger amount of their goods to their store base (like retailers) could be hit with higher-than-expected costs and therefore suffer on the earnings front.

Again, investors might try to review macro events as they take place and are reported and then try to think them through to their possible completion. This may help them better understand what impact if any they may have on the company they are invested in. Now, some may think that keeping tabs on the news is too burdensome. But those people might keep in mind that many Wall Street traders and analysts tune into news feeds throughout the day to monitor macroeconomic events that transpire.

Finally, a company's 10K and/or quarterly reports may also shed some light on macro events that could transpire that could have an adverse effect on the company.

Know the Expectations
If a company generates a large profit in a given quarter, that's great. But if analysts were expecting an even larger profit the stock could tank. In short, it's vital that investors and traders be aware of what the expectations are. It may allow them to pick a better entry point. (Want to invest but don't know where to start? Learn how to make your money work for you with the tips in Learn To Invest In 10 Steps.)

Conclusion
It's great for an investor to understand the company's basic story, products and services. However, it's also important to understand the potential risks and negatives that could have an adverse impact on the company and, by extension, the share price.

Related Articles
  1. A Monte Carlo simulation allows analysts and advisors to convert investment chances into choices. The advantage of Monte Carlo is its ability to factor in a range of values for various inputs.
    Fundamental Analysis

    What Can The Monte Carlo Simulation ...

  2. With a long list of risks, losses associated with foreign exchange trading may be greater than initially expected. Here are the top 5 forex risks to avoid.
    Economics

    Top 5 Forex Risks Traders Should Consider

  3. ISAs are financial instruments that allow students to raise funds to pay for their degrees by selling shares in their future earnings.
    Investing Basics

    Funding Higher Education With An ISA

  4. Top Ways to protect your purchases from credit card hackers or security breaches.
    Credit & Loans

    7 Ways To Protect Against Credit Card ...

  5. Markets

    The Fear And Greed Cycle Lives On

Trading Center