How to Tell If an Investment Is Good or Bad

If a company has rising profits and sales, a declining stock price could represent a good investment.

If a company has rising profits and sales, a declining stock price could represent a good investment.

For a person trying to identify solid investment opportunities from among the plethora of available choices, being able to identify financial securities as distinctively good or bad would be helpful. It's not always a black-and-white task, however, and some of the process of separating the wheat from the chaff depends on your own good judgment. There are some red flags that forewarn of a potential losing bet, however, as well as some positive signals that could lead to a profitable investment.

Stock Price

Review a stock's historical price changes over the past 12 months to get a sense of overall performance. Historical closing price data is available on financial websites and -- in some cases -- on the investor relations pages of companies' websites.

Calculate the stock's price-to-earnings ratio. It's determined by dividing the stock's current price by the average earnings per share over the past four quarters. Earnings information is available in quarterly reports filed on Form 8K, which may be accessed on the SEC's website EDGAR, through each company's investor relations web page, and on many financial news websites -- including Yahoo Finance.

Compare the results with the average P/E ratio -- approximately 15 -- for companies that trade in the S&P 500 Index. If results far exceed or severely miss the P/E market average, the stock is either priced too low or too high, which is a signal to investigate the investment further before grouping it in the good or bad camp.

Balance Sheet

Look at a company's most recent financial statements included in quarterly reports. Determine if the company is profitable. This is usually made quite clear. If profits are eluding the company, they might escape your investment portfolio, too.

Compare profitability, sales and market share with other companies of the same industry. If the stock enjoys some competitive advantage, it could be a good investment because it may dominate sales in that segment. For example, technology sector company Apple's competitive position with its iPhone products help push the stock to repeated new high prices, according to a 2012 MSN Money article.

Identify the economic risks common to the industry in which you are considering investing. Weak consumer spending, for example, can make retail stocks bad investment choices if you're hoping for short-term gains. In the long run, however, and when economic conditions improve, these stocks could prove to be good investments.

Bonds

Identify the yield -- the return expressed as a percentage -- on bonds that you are considering. Given bond nuances, it is helpful to use an investment calculator to learn a bond's yield. Compare the resulting yield with other bonds to learn if you're getting a fair return.

Separate potential bond investments into two categories: investment grade and non-investment grade. The former are the most reliable, while non-investment grade bonds pay higher yields but include a threat for default. Whether or not it's a bad investment choice depends on how low on the investment-grade scale the bond is rated and how well you handle risk.

Figure out when you will need to have your principal investment back. Some bonds mature in a couple of years, but others mature for up to three decades. If a bond's maturity date does not coincide with your investment timeline, it could be a bad choice for you.

Items you will need

  • Computer
  • Calculator

Tips

  • Financial analysts often rate stocks and bonds, which can help you make good investment choices.
  • Read the annual reports of stocks you are considering buying to learn about the company's goals.

Warnings

  • All investments carry at least some risk of financial loss.
  • Stocks can be volatile and bonds may produce only minimal returns.

About the Author

Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.

Photo Credits

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