4 top lessons the Theranos scandal can teach us as investors 

The Theranos story presents a timely reminder of some age-old investment wisdom that can help me avoid some basic stock-picking pitfalls.

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I, like many of you, will be watching the gripping miniseries, The Dropout. It unpacks one of the most bizarre cases of corporate fraud you will ever see. By a blood-testing start-up called Theranos, no less.

The company managed to dupe many high-profile investors. It shows me that I am never too old to learn an investment lesson.

Putting the Theranos case study into context

So, in 2014 Elizabeth Holmes was a 30-year-old billionaire. She had founded a company valued at $9bn (£6.5bn) for supposedly bringing about a revolution in diagnosing disease.

The only problem? The technology didn’t work.

Soon enough, Holmes was exposed as a fake. In honour of the high-profile debacle, here are five lessons from the Theranos story that continue to serve me well in my investment journey. 

Always evaluate the track record of the management team

Firstly, a big clue is in the title of the miniseries – The Dropout. The fact the CEO of the start-up was a university dropout with no track record in the medical industry is an immediate red flag for me.

The saying goes, “there are no bad companies, only bad managers.” To invest, I must believe beyond doubt that the management team are competent and know what they are doing. Otherwise, I don’t!

Don’t worry about other people

As with many trends in life, herd theory occurs in finance when investors follow the crowd instead of their own analysis. In the case of Theranos, the crowd included bigwigs like Larry Ellison and Henry Kissinger. But, no matter how clever I believe my potential co-investors are, it will never be enough to convince me to invest in a stock. At least not unless I have justified this with my own view.

I never invest in businesses that I do not understand

At one point Theranos claimed to be able to perform all manner of tests, ranging from cholesterol levels to complex genetic analysis. All with just a single pinprick of blood.

Admittedly, I am no geneticist, and haven’t met many. This, in all likelihood, means that I will not understand complex genetic analysis. That is my personal signal to avoid investment.

If I don’t understand a stock, I do not invest in it.

I avoid concentration risk at all costs

Concentration risk occurs when I rely too much on a single investment; for example, a single company’s shares.

So, my prime objective is to avoid an over-reliance on a particular stock or security. My portfolio could be exposed to severe losses if the company goes bust. This turned out to be the reality for many an investor in Theranos.

As such, I counter this by spreading my investment risk by diversifying across sectors, asset classes and regions.

I will never invest in a business I do not understand

In conclusion, investment sage Warren Buffett once said “never invest in a business you cannot understand”. This is the rule I have found to be the most important in my stock-picking journey.

As an investor, independent thought and analysis has served me well.

In the end, I’d rather blame myself for my investment mistake, than someone like Elizabeth Holmes.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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