The best way for investors to avoid fraud is to review their investment strategy and research process

A new study advises investors to reevaluate their research strategy to avoid fraud. Photo: Zadorozhnyi Viktor | Shutterstock.

When a corporation commits fraud, they can hurt individual stockholders, who lose money as stock in those companies fall. Savvy investors consider the potential for fraud when evaluating a company before purchasing stock, but not all such investors are paying attention to the right warnings.

A recent study, published by researchers at North Carolina State University, George Mason University, the University of Virginia, and the University of Cincinnati, surveyed 194 experienced, non-professional investors to see how they protected themselves from fraud. They found that many of their subjects did consider the possibility of fraud when choosing where to invest, but they often looked for red flags that appeared too late.

For example, keeping an eye out for federal investigations often resulted in a loss of capital because, by the time such investigations come to light, the company’s stock may have already dropped.

They found that more successful investors, who were protected from fraud-based losses, considered a number of other factors when choosing to invest, or deciding whether to keep their stock. They kept an eye on changing management, which could be an early sign of trouble. They also tended to have more diverse portfolios, so there was less chance of one failure ruining them, or of one company’s fraudulent actions hurting other companies in their portfolio.

They also found that investors were more inclined to consider fraud as a possible issue if they tended to believe that corporate fraud is common. Investors were also more inclined to consider fraud risk if they made their decisions based on financial information rather than on news reports or advice from professionals.

The best way to protect investors from fraud-based loses is to better inform them about the risks. The researchers suggest establishing a website based on tracking such red flags before they could cause harm.