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What To Do When A Stock Looks Too Good To Be True?

The numbers say YES INVEST, but your gut says NO.


Maybe it’s a woman’s 6th sense, your instincts, or your gut that says no, this stock doesn’t feel right. Call it whatever you want, but sometimes, this uneasy feeling that the stock is just not quite right might be based on subconscious information processed in your brain.

A stock that offers a high dividend yield could entice many investors. But also remember that returns do not come without risk. You might think you’re getting a bargain for a stock that gives such positive returns. However, there’s a lot more to consider before concluding that the stock is a good, worthy investment.

Fundamental Analysis Supports Investment Decision

Most people have a list of criterias the stock has to meet before they invest in it. This set of criterias can differ from person to person, based on their investment objective, strategy and risk tolerance.

High dividend yield is one of the major factors that encourage us to invest in a company. However, many investors look at other factors aside from dividend yield such as Return On Equity (ROE).

As investors pour through a company’s financial statements, they usually look out for numbers like gross profit, cost of goods sold, revenue, net profit, dividends and more.

To help us understand the company’s financial position and value, we take these numbers and calculate ratios and margins. We calculate ratios such as the debt ratio, current ratio and profitability ratio; margins such as gross profit margin and net profit margin.

Sometimes we find a few companies that fit our shortlist of criterias. However, some of these companies seem dubious at times, being relatively unheard of to investors. Their high returns seem questionable, their business model, unclear.

When a stock looks too good to be true, it usually is. A savvy investor should find out more about the company rather than jump the gun and invest money just because it meets the various investment criterias set in place.

Read Also: The Battle Between Fundamental And Technical Analysis

What Else Should You Look at?

Before you decide to invest in the stock, look deeper into other criterias. Look at the market dynamics and trend at the moment, as well as investor sentiments.

You should also compare the company’s numbers to those of its competitors in the same industry. As good as their numbers might look, they should not deviate too far from those of competitors, unless of course the company is a monopoly or a major market player. As the markets differ from industry to industry, it’s important to know the industry background, demand as well as their big players.

The management team of the company is also another crucial factor often overlooked by investors. The management team sets the direction and goal of the company. A capable and credible management team would be able to gain the trust of investors and drive the company forward.

Advice From Peers

It’s also a good idea to talk to some of your peers that are experience investors. It’s possible they’ve seen a similar stock before and could give you better information before you choose the stock.

Besides advice from peers, also look at the general market sentiments of investors as well as the buying and selling behavior of the stock.

Read Also: How You Can Use Fundamental And Technical Analysis Together

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