How do I avoid buying shares of a company that might go bankrupt?

Investing with moomoo joined discussion · Jun 25, 2021 03:16

How do I avoid buying shares of a company that might go bankrupt?

By Melody

As we start our investing journey, we might run into all kinds of situations. One of these situations would be the case where we hold shares of a company that has filed for bankruptcy. As soon as it happens, we will see a significant drop in share prices.

In order to avoid being in this situation, what should we do?

First, we have to understand why companies go bankrupt.

Businesses that go bankrupt don't usually do so because they're not profitable. Rather, they go bankrupt because their cash reserves run dry, and they can't meet current payment obligations. An otherwise profitable company may also run out of cash because their capital requirements continue to increase in order to support additional investment in inventories and accounts receivable as they grow.

What should we look at to help us as an investor?

The working capital ratio(aka current ratio) can help us avoid this pitfall.

Working capital represents a company's ability to pay its current liabilities with its current assets. Working capital is an important measure of financial health since creditors can measure a company's ability to pay off its debts within a year.

Assessing the health of a company in which you want to invest involves understanding its liquidity—how easily that company can turn assets into cash to pay short-term obligations. The working capital ratio is calculated by dividing current assets by current liabilities.

Here is the formula:
WORKING CAPITAL RATIO = CURRENT ASSETS ÷ CURRENT LIABILITIES

But how can I look up working capital ratio(current ratio) on moomoo?

For PC users:

For mobile users:

What is a healthy working capital ratio?

Anything in the 1.2 to 2.0 range is considered a healthy working capital ratio. If it drops below 1.0 you're in risky territory, known as negative working capital. With more liabilities than assets, you'd have to sell your current assets to pay off your liabilities.

Got a ratio over 2.0 and think you're golden? It's not quite that simple. Higher ratios aren't always a good thing. Anything above 2.0 could suggest that the business isn't using its assets to its full advantage.

Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only. Read more