5 Signs a Stock Is a Terrible Investment

With the right online brokerage account, stocks can be a great financial instrument to enhance your financial portfolio. They can diversify your holdings and help your capital appreciate. But it’s important to recognize and understand red flags before you buy to minimize any financial losses. Pause and reconsider if a stock has high dividend yields, declining earnings, or high debt levels, for example. Let’s take a look at some of the risks that come with investing in stocks and explore the red flags even further.

Understanding Stock Investment Risks

Stocks are among the most widely held investments out there, especially for long-term investors. In fact, as many as 62% of Americans reported owning stocks in 2025. But, as popular as they are, they come with inherent risks you should understand. They include:

• Market risk: Also called systemic risk, market risk affects the entire stock market or specific industries. This means your stocks can drop in value because of certain factors like economic considerations or political upheaval. While you can find ways to reduce the amount of market risk you’re exposed to, you can’t eliminate it.
• Business risk: This is anything that can negatively impact a company and its financial position. These factors can be internal and external—anything from operational issues and management decisions to competition and economic conditions. Business risk can affect a company’s profitability and its future growth prospects.
• Liquidity risk: Liquidity risk refers to the potential for problems selling your shares or getting a fair market value (FMV) for your stock on the secondary market. This may be because there aren’t enough buyers in the market.
• Interest rate risk: Changes in interest rates can impact the value of your stock holdings. Companies that rely on debt financing may see their profits drop when interest rates rise because borrowing becomes more expensive, which means the value of many of your holdings could drop, too.

The Red Flags of Terrible Investments

Sign 1: Unsustainable Dividend Yields

Dividend-paying stocks are highly sought after by many investors. They are considered a great source of income, show long-term growth, and provide financial stability. But they do come with drawbacks—notably, the dividend value trap.

This happens when you chase a stock because it has a high dividend yield, only to find out that its value drops or the company cuts its dividend in the future. Unusually high dividends may seem attractive, but they generally aren’t sustainable. A very high dividend often means that the company has financial problems because it is paying investors more than it can afford.

Sign 2: Declining Earnings

If the company you invest in sees a drop in earnings, you’ll want to take a step back and reevaluate it. The drop may be temporary because of a downturn or higher costs. Or the stock may be underperforming for a couple of quarters. This may not be much of an issue, especially if the company can bounce back.

Your shares could lose value if the company’s earnings continue to drop over multiple periods. This is likely due to several factors, including the inability to raise capital, a loss of investor confidence, increased costs, and a drop in revenue. Along with stock price volatility, expect to see other problems, notably a cut or elimination of its dividend (if it offers one), and cutbacks to its workforce.

Sign 3: Negative Free Cash Flow

Negative free cash flow means that a company is spending more money than it’s bringing in from its core operations. This isn’t necessarily a bad sign in certain cases, especially for new or growing companies. It can be problematic for established companies, though.

A company in this situation may not be able to pay its short-term debt obligations and may have trouble paying its dividend, if it offers one. Limited cash flow can also impact the company’s ability to keep up with its day-to-day expenses, marketing, research and development (R&D), and payroll.

Sign 4: High Debt Levels

Most companies have debt, which they can use as a tool for growth. But having too much debt can pose a risk to the company and its investors. While there’s no threshold, you can tell whether a company has too much by reviewing some of its financial metrics, such as its debt-to-equity (D/E) ratio. In general, a D/E ratio of 2.0 or higher can be risky.

Higher debt levels pose an increased financial risk to companies and their investors. It increases the amount of interest they have to pay on their debts and lowers the amount of free cash flow. If this keeps going, it can increase the risk of default and even bankruptcy. This can increase volatility and put downward pressure on your stock holdings.

 Sign 5: Industry Challenges

Companies can face numerous industry challenges that can disrupt their growth and success. These include competition, inflation, supply chain disruptions, inventory management, compliance issues, and problems retaining talent.

Long-term structural challenges can have a lasting impact on a company’s performance as well as its stock value, causing its stock price to drop. It can also put pressure on corporate earnings and profitability as the company must find ways to compete with others in the market, spend money to innovate, adapt to new technologies, and invest in new products.

The Bottom Line

Stocks are a great way to invest and grow your wealth. But before you dive in, you should have a solid understanding of how they work. This includes knowing all the risks and red flags that come with them. Being knowledgeable about what makes a stock a bad investment can save you a lot of money in the long run. If you’re still unsure of what to look out for, make sure you speak with a financial professional who can guide you through the process.