This week on Money and Investing, Mitch Olarenshaw and I discuss the red flags to watch for in the stock market, helping investors stay sharp and protect their portfolios.
1. Watch for Overvaluation
One of the most obvious warning signs is when a stock becomes too expensive. A high price-to-earnings ratio, especially based on forecast earnings, can indicate trouble. Commonwealth Bank, for example, is the most expensive bank globally—but with limited room for growth, that valuation may be hard to justify.
2. Understand Valuation Metrics
PE ratios are a common way to assess value, but they rely on future earnings, which are difficult to predict. Factors like interest rates, inflation, and exchange rates can affect those estimates. Compare valuations with other businesses in the same sector for a better context.
3. Low Volatility Can Be Misleading
When volatility drops and sentiment is high, many investors relax. But this is often when risk is building up. Use these calm periods to prepare, using tools like options to lock in profits or protect against losses.
4. Separate Hype from Real Growth
Some companies trade at high valuations for good reason. Nvidia is a strong example, with clear earnings growth and a role in powering the AI sector. In contrast, banks and other mature industries may not have the same upside potential.
5. Watch Economic Indicators
Rising unemployment is a major concern, as it slows down spending and weakens the economy. Inflation and interest rate hikes can add pressure, making the environment harder for both businesses and investors.
6. Learn from Past Crashes
Each crash has its trigger. The dot-com bust, the GFC, and COVID all had specific catalysts. Understanding these can help you recognise early signs and adjust before the damage is done.
7. Follow a Clear Process
Avoid emotional decisions by having a checklist. Consider valuation, chart levels, earnings, dividends, and risks. Make sure the stock suits your strategy — don’t rush in just because others are buying.
For more Info about Money and Investing you can go to the podcast; The Wealth Playbook: Your Ultimate Guide to Financial Security; and, The Wealth Playbook by Andrew Baxter – Audiobook which is on Audible.
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