Value Investing in Asia

Chapter 7Finding Red Flags

Fool me once, shame on you; fool me twice, shame on me.

— Proverb

When it comes to investing, knowing what to buy is just half the equation. Given our investment criteria, it is not often we come across a company with a perfect score. This means that we often research a company which ends up not being an investable opportunity. After a while, many investors might get impatient and rush into investing in a sub-par company. Remember: as much as being able to find winners, investing also greatly depends on your ability to avoid losers. Thus, knowing when not to put your money in is more than half the battle won. Let the last part of the statement sink in.

We repeat, knowing what not to buy is more important than knowing what to invest in. After all, in the stock markets, ideas are almost unlimited while our investable capital is always limited. And statistically, it is far harder to gain back our losses. Remember, if you are down 50%, you need a gain of 100% just to break even.

For simplicity, you can look at “knowing what not to buy” as a form of screening. Earlier we used screening to filter for companies with positive traits. In this case, we are adding an additional layer to filter out companies with negative traits.

Let us find out how to uncover red flags in a company.

What are Red Flags?

A red flag is a sign that warns us of incoming danger. However, we like to point out that the presence of red flags does not always mean that things are ...