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vol. XV no. 3
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Some rules of thumb to help steer clear of big losses.
Amid all the uncertainty, how does the individual investor avoid getting caught holding shares of the next Enron? Market analysts offer some rules of thumb to help steer clear of big losses:
- Bank on companies that grow mainly from within instead of
by absorbing lots of other firms. Tyco is just one troubled case in point.
- Read up on companies. Look at their pension plans; if the projected annual rate of return is too high, a shortfall could
eat away at future earnings. Keep an eye on off-balance-sheet liabilities and development costs that are capitalized instead
of expensed. WorldCom treated routine expenses as capital investments.
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Watch out for big spenders - companies that pay their managers more than $100 million a year in cash and stock. Beware if any of the top managers are former employees of the firm's independent auditor or if they're receiving large loans from the company.
- Check the statements, especially the cash flow statement. Net income and cash flow from operations should move in the same direction at similar rates. Net income rising more rapidly than cash flow can be a sign of accounting irregularities, as it was at Enron.
- Look for heavy debt. If debt is greater than half of total capital or more than five times free cash flow, a company has little margin for error (WorldCom again).
"Now is actually a good time to invest to see high future
returns," Green noted. "With that said, the fundamentals of investing still hold: diversify, buy and hold, and minimize expenses. Don't bank your retirement on your company's stock. And don't plan to make a lot of money fast - the stock market is a place for long-term investors."
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