“What stocks should I invest in?”
You’ve probably asked this question many times.
Maybe you’ve even googled it in frustration. But there’s another question you should ask (or google) first, and that’s:
“What should I avoid investing in?”
There are two reasons why this should be your first question:
1. It’s going to take you a long time to play catch-up if you lose money.
2. It’ll be easier for you to find good investments if you have a system for discarding the bad ones first. You can waste a lot of time researching a company just to discover at a later stage that it’s a no-go because of one of the 10 reasons I’m going to list.
Are you ready to discover what you should avoid?
1. Companies You Don’t Understand
Don’t invest in something you don’t understand.
It’s really important that you have a good grasp of the product or the service that the company delivers. If you don’t, you can’t know whether it’s really a wonderful company with solid products that will sell more in 10 years.
You’ll make yourself vulnerable to fraudulent companies because, without you following along, the management can create fiction about how it’s going.
2. Companies with Bad Management
Invest in companies that are run by trustworthy and competent people.
But what is good and what is bad management?
You have to use your ability to read people and ask yourself whether you trust the management. Look at the results they’ve created. Watch videos and interviews with the CEO.
Look at body language and facial expressions and notice how he or she responds to criticism.
One important sign of honest management is that you actually understand what they’re saying. Some technocrats hide behind industry jargon, and that’s usually a red flag.
3. New Companies and IPOs
You need at least 10 years of annual reports to be able to paint a fair picture of the company.
You’re trying to predict how the company will do in around 10 years. You can’t do that based on a startup’s initial years.
Companies that are going public, called IPOs (Initial Public Offering), are risky for two reasons:
- They go public with a big sales team behind them that can hype the stock price.
- IPOs often happen in times of an overvalued stock market where the price is more beneficial to the original owners than the new shareholders.
4. Companies That Lose Money
Stay away if the company doesn’t make money.
It’s not a good investment to become an owner of a business that spends more money than it makes.
Just like – from a financial standpoint – it’s not a good idea to marry someone who buys a jet on a teacher’s salary.
If they operate with a deficit, they have a hole in the bucket where the water is running out.
5. Companies That Are Shrinking
If the sales are declining, stay away (even if they’re making money). It’s not a good sign.
They could be losing customers for three reasons:
A. They are losing market shares to competitors.
B. The whole market is disappearing, maybe because something better was invented.
C. They are going through some kind of event that could be overcome.
The first two reasons are a no-go.
If C’s the case, you should not have more than a few months of declining sales and you should be able to identify the exact reason why it’s happening and how they are addressing it.
6. Small Companies
Don’t invest in something that has a market capitalization (market cap) of less than 1 billion USD.
What’s market cap? It’s what the company is worth at this very moment (number of shares X stock price). You can easily find it by googling “market cap”.
If you invest in small companies, you run the risk of the stocks freezing up and you not being able to unload the shares when you want to get out.
7. Companies in Developing Countries
There’s a lot of trust involved in investing. You have to trust the government, the laws, the institutions enforcing the laws and the whole support structure surrounding the company, like the accountants doing the books.
In other words, if it’s a US company you invest in, you trust the US Government, the relevant US laws, the Security and Exchange Commission (SEC), and the accounting firm they use.
I don’t invest in Chinese companies for this very reason. I don’t feel sure about the government’s predictability, the regulation (China has, among others, inadequate regulation on insider trading), the enforcement or the accounting practice.
8. Companies with Variable Results
If the numbers go up and down a lot, stay away from investing in the company.
It’s hard to calculate what the company is worth because there will be no “normal” year you can base it on.
Some industries have inherently fluctuating results, because one single order is the size of a whale. That’s the case with companies that produce wind turbines. An order is usually not a single wind turbine but rather whole parks.
It’s hard to predict anything in this kind of company.
9. Pharmaceuticals and Biotech Companies
Pharmaceuticals and biotech companies run a lot of complicated research projects to develop new medicine.
What happens in the laboratory can have an enormous influence on both the future sales prospects and the stock price today.
It’s hard to predict, and it’s hard to understand. There can be “bombs” in both the pipelines of the company you are looking to invest in – and also its competitors.
If a development project in your company of choice tanks, the future tanks. If a competitor’s development project has a breakthrough, the future of your company of choice tanks too.
10. Financial Companies
Yes, Warren Buffett invests in banks and insurance companies, but that doesn’t mean you should.
Financial companies are complex. Banks can have a lot of nasty stuff hidden deep inside their books.
Maybe they are vulnerable due to certain loans they’ve made or maybe they are invested in some complicated products that they don’t really understand themselves (think Financial Crisis).
Both banks’ and insurance companies’ annual reports deviate from a normal company’s annual report. You’ll find that it’s difficult to do some of the most popular calculations on them, like Warren Buffett’s owner earnings.
What Else to Avoid?
Obviously, having this list doesn’t mean you can invest in anything that’s not on here.
This list is just the first strainer you’ll use.
Next, you’ll use a check list to find a great company. You are welcome to borrow mine here.
Don’t forget to read my free e-book that explains my whole investing process – including my favorite way to calculate what a company is worth. You can get it here.