3 Tips To Avoid Buying Into A Fraudulent Company

What is the worst nightmare for an investor?

It is not experiencing a market crash. It might be realising that you have invested in a fraudulent company which has just been exposed, resulting in its share price crashing and burning.

Here are three simple tricks to help you avoid such a company from entering your portfolio.

Avoid Initial Public Offerings

Newly listed companies can be very exciting. Many of them have an attractive growth story and seem to have a good potential. However, these companies also lack track record as a listed company. This means that there is very limited information about them, its management or its main shareholder.

By controlling your urge to invest in these companies, you can lower your chances of investing in a fraudulent company. Moreover, if they are indeed great companies in the making, it would not be too late to invest in them again a few years down the road. After all, great companies can continue to be great for decades.

Avoid “Too-Good-To-Be-True” Companies

Fraudulent companies tend to fabricate their financials. This means they often fake their companies’ financial performance. If a company has great margins, great cash flow, great return on equity, great growth and seems so perfect, even when all its competitors are struggling, maybe it is just a fairy tale. The best thing for us to do, then, might be to just move away.

Follow The Chief Financial Officer

Fraudulent companies tend to have questionable financial statements. In most companies, the person closest to the financial statements would be the Chief Financial Officer (CFO). Therefore, if a firm experiences too many changes its CFO within a very short span of time, it might be a huge yellow flag for investors to take note of.

Foolish Summary

There is no fool-proof method of avoiding investing in fraudulent businesses. However, we can surely reduce our chances of falling prey to them by taking note of the three suggestions.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.