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Learn to Evaluate Financial Information

by Amy Buttell / July 11th, 2011

Americans suffer from an overload of financial information. It's in the newspaper, on untold numbers of websites and cable television stations, and in your snail mail and e-mail. How do you sort the reliable from the junk? Is it better to leave investing decisions in the hands of trained professionals and wash your hands of all of it? Absolutely not. Sorting good information from bad isn't that hard. Although numbers can certainly be manipulated, direct data from company sources and trusted independent investment providers is high up on the reliability list. Contrast that with the hot tips offered in numerous chat rooms, and you'll see that understanding where information comes from goes a long way toward determining its validity. While the Enron and WorldCom corporate scandals of the early 21st century cast a pall on company financial information, followed more recently by Lehman Brothers' collapse and other market excesses, Congress and the Securities and Exchange Commission (SEC) have taken steps to ensure the validity of company financial statements and reports and increase their transparency.

If it's too good to be true...

There's a truism that if something is too good to be true, it probably is. By using your common sense, you can eliminate much of the hype that surrounds the stock market from consideration. If you get e-mails, chat room messages, or calls from brokers claiming that a certain stock is guaranteed to increase X amount in a short time, disregard them. No one, not Warren Buffett, Jim Cramer, or your local stockbroker, has a crystal ball. Investing in the stock market always carries risk and there are no sure things. In fact, investing in a "sure thing" that you don't understand is one good way to increase your risk rather than decrease it. If you don't understand a particular investment being pitched, don't invest in it. At the very least, request more information in writing before making a commitment. Remember that you are perfectly entitled to decline to invest in something that you don't want to. "No" is the best way to stop persistent brokers or market hypers.
Ask questions if something seems too good to be true.

Check the facts

Whether information is coming from a reliable or not-so-reliable source, check the facts—before, not after, you invest. You may hear that a particular company is bringing out a new product that will boost its stock price. Go to the company's website and check it out. One new product, no matter how good, does not a company make. The new product may not succeed, or it may involve a small part of a large company's revenues. If you find out something about a company from an employee or other insider, think carefully before acting on it. First of all, such information can be virtually impossible to verify. Second, if this information is true and will affect the stock price of the company, that insider might be acting illegally; you could get in trouble for trading stock based on inside information. Don't forget about Martha Stewart, who was convicted on charges related to an insider trading scandal.

Truth in numbers

How reliable is even the data that comes directly from companies and supposedly is subject to independent audit? The truth is that numbers, like anything else, can be manipulated. The saying "There are lies, damn lies, and statistics" isn't too far off the mark for any type of numbers or financial information. However, in the aftermath of the various corporate scandals, Congress and the SEC have taken steps to strengthen the quality of financial reporting. The Sarbanes-Oxley Act of 2002 requires company CEOs and chief financial officers to certify their quarterly and annual financial statements. If financial statements don't meet Sarbanes-Oxley standards, these officers are subject to severe sanctions, including jail time. In addition, the act and further SEC rules limit the use of "pro forma" earning numbers, making it easier for investors to understand the differences between pro-forma numbers and those required by generally accepted accounting principals (GAAP). There are a number of other provisions in this act that affect outside accounting firms that conduct corporate audits, the role of corporate attorneys, and the independence of company boards of directors.
If you don't understand a particular investment being pitched, don't invest.
The Enron and WorldCom scandals did reveal big problems with corporate governance practices at these and other companies. But despite these problems, most company officers and managers are honest and the truly egregious cases of wrongdoing are by far the exception rather than the rule. The Dodd-Frank Act signed into law in 2010 is meant to add further confidence in the markets by promoting financial stability, accountability, and transparency in the financial system.

The turtle vs. the hare

Investors with a long-term attitude who take the time to learn something about the companies they invest in and to verify information are more likely to prosper than those after the fast buck. You don't have to read every footnote in a company annual report to get a good sense of what a company is all about. By learning about its products and services, assessing its growth characteristics, and evaluating management, you can get a good idea after a couple of hours' study whether a company is a worthy investment or not. Ask questions if something seems too good to be true. There are many publicly traded companies that won't make the cut. But that's OK, because you want the best growth companies the market has to offer. With those companies in your investment portfolio, you're more likely to meet your wealth-building needs for a secure retirement and for a sound college education for your children.
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This article was originally published by BetterInvesting. Since 1951, BetterInvesting has helped more than five million people become better, more informed investors. BetterInvesting helps its members build wealth through educational webinars, Web-based mutual fund and stock tools, in-person learning events, publications, an active online community, and software. For more information, visit the website or call 877-275-6242. Neither CUNA nor the author of this article is a registered investment adviser. Readers should seek independent professional advice before making investment decisions.
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