How to Spot Weak Investments Before They Crumble

It’s probably wise to keep your eye on your car’s dashboard as you drive to work — forget to glance at the gas needle and you may soon coast to a halt. Wall Street guru Warren Buffet’s recent annual shareholders’ letter reminds us that the gauges of any company you invest in must pay careful attention to the ABCs of business decay.

In your money matters, those three little letters stand for arrogance, bureaucracy, and complacency. Any such sign serves as a possible warning that your dollars may be at risk.

Arrogance

Any business at any time can easily believe that its products or securities offerings trump the competitors’, or that the marketplace is more promising than reality (or common sense) shows. Yes, you can have a hard time identifying arrogance. We all expect a chief executive officer to voice full support and enthusiasm about his or her company’s latest widget.

At such a time, business fundamentals become very important to you, the investor. Make sure the company in question doesn’t use too much leverage (debt) to promote and bolster the offering’s debut.

Also make sure the company’s sales projections reflect strong yet realistic growth. Even good sales can’t always keep a stock safe from shareholder doubt, as the ambitious eatery chain Shake Shack recently discovered. Shake Shack (SHAK), the high-end burger chain, had an excellent initial offering of its stock this winter, but quarterly earnings reported in March showed so-so growth in per-store sales, which led to a sharp drop in share price.

Arrogance often occurs when one company buys another that has a different business model or marketed product. Just because a firm excels in one area doesn’t mean it will achieve similar good results in a new field.

Source: Thinkstock

Source: Thinkstock

Bureaucracy

Government regulations and rules can be game changers for a business, especially changes in tax and social policy or in demographic shifts. But that only happens up to a point. Buggy makers didn’t go under because of regulations, for example, but ceded relevance to the technological innovation that you and I now call a car.

On the other hand, manufacturers do shut down due to changing requirements from the Environmental Protection Agency or other regulators that impose higher compliance costs and potentially harm a company’s sales figures. Recent examples of industries that regulations push hard include telecommunications and health care.

More will no doubt follow: Even the EPA doesn’t always realize the extensive dollar costs of its own rules. Watch Washington closely for changes that might hurt your portfolio.

Complacency

Each day in business, a company either gets better or worse. There’s no such thing as the status quo for quality operations, at least in theory.

Author Jim Collins points out that the enemy of business greatness is when a company settles for just being good. Many companies reach a point where today’s promise of good makes management hesitate to make the changes – sometimes risky ones – that might elevate the firm to greatness.

Companies that achieve consistently good numbers tend to lapse into mere maintenance and stop striving. That strategy isn’t necessarily bad for a company or for an investor, but you need to know that’s the plan before you invest further.

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Joseph “Big Joe” Clark, CFP, is the managing partner of the Financial Enhancement Group LLC, an SEC Registered Investment Advisory firm in Indiana. He teaches financial planning at Purdue University and is the host of Consider This with Big Joe Clark, found on WQME and iTunes. He is a Registered Principal offering Securities and Registered Investment Advisory Services through World Equity Group, Inc, member FINRA/SIPC. Big Joe can be reached at bigjoe@yourlifeafterwork.com, or (765) 640-1524. Follow him on Twitter at @Big Joe Clark and on Facebook at http://www.facebook.com/FinancialEnhancementGroup.

Securities offered through and by World Equity Group Inc. Member FINRA/SIPC. Advisory services can be offered by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.

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