Always examine the balance sheet
This is an essential aspect of protecting the downside. Typically when investors lose their shirts, there were warning signs in a risky balance sheet.
Balance sheet formats can vary, but don't be put off or feel you 'have to be an accountant' to understand them.
The essentials are pretty simple and nowadays it's easy to look up definitions online or in "interpreting company accounts" books. If you browse patiently, the details will piece together and this forensic aspect of investment research can be intriguing when you pick up on oddities.
Keep an open mind that balance sheets do vary with the business.
Some investors avoid intangible assets like the plague, preferring physical asset backing of the kind you see in property or financial investment companies. Yet many modern successful businesses do tend to be people or brand-oriented - and so you are engaging intangibles. This is another key aspect, how Warren Buffett changed his style in the 1960s, with enormous success, as a result of favouring firms with the strongest brands and managers.
The main risk is probably where such a firm capitalises substantial goodwill and intangibles as a result of paying over book value during an acquisitions' spree; which combined with significant debt is often where the company comes unstuck when trading turns down.
Always examine a firm's the short-term liquidity situation; how current assets versus current liabilities balance out, as a firm which is unable to meet its short-term creditors may be in a precarious position.
Look at how any debt is structured and check back to the income statement to see how the net interest charge relates to operating profit.
It's also worth investigating - for example reading any published reports about the company - whether there is market awareness of novel financing arrangements which may not be disclosed on the balance sheet but effectively increase liabilities hence risk. This was a key flaw in many people's perception of bank shares, before the bust which hedge funds exploited by selling short.
Among plus points, a rising cash balance is a good sign of overall health - although nifty managers may also quickly be deploying it within the year, for investment for future growth. You can see how all this interacts by looking at the consolidated cash flow statement, which tells you how funds have been generated and applied.
Dividing a firm's net income by its capital employed, especially net assets or equity (which in essence, have to 'balance') gives you the return on capital employed which is one very useful measure of financial success - but needs setting in overall industry context. An agency-type business necessarily uses a lot less capital than, say, a property developer.
Overcome any phobia about figures, and all such forensics can turn fun.
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