When looking for good stocks to buy using a longer-term value investing approach, I am immediately faced with the multitude of companies that are listed on my stock market. I handle the task of how to buy good stocks by narrowing down the field of companies to those that seem to provide the most value with the least risk.
If I can rule out a substantial number of riskier companies for good reason, it would help reduce the complexity of the task. Listed below are the classes of companies that I generally dismiss for the reasons described. By eliminating these companies, you will be more likely to minimize risk by choosing from the remaining companies.
Initial public offerings (IPO)
These are companies offering shares to the public for the first time by requesting their listing on a stock market at a listed price through a prospectus, a document that provides essential details about the company. I generally avoid this kind of investment.
IPOs, or initial public offerings, are often issued by smaller, younger companies looking for additional capital to expand, but they can also involve larger private companies looking to go public.
IPOs can be a risky investment, as it is difficult to predict what stocks will do on their first day of trading and thereafter. There is often little historical data to analyze the company. The directors set the listing price to be paid by the investor. You can be sure that they will price at a level that guarantees a good profit.
But will you make a profit? Do not gamble unless you can be sure that there is a large group of bettors who hope that they too can make a profit, and that they are enthusiastic enough to increase the price of the listing price.
Single resource companies
These are companies that often explore and develop mineral or oil resources. Companies that extract or explore a resource are highly dependent on the price at which they can sell that resource, if and when they can trade it.
So if you buy a single resource company, you are betting that the price of that resource will go up. Unless your sources of information are better than most, you are in a high-risk enterprise. I prefer low risk companies!
Capital intensive industries
They are companies that require large amounts of expensive equipment, machinery or aircraft to trade. Take, for example, steel mills, automakers, and airlines. Why do I generally avoid them?
Unless companies continue to inject large amounts of their profits into new equipment, they will lose their competitive advantage and, one way or another, those profits will be lost to shareholders.
Penny stocks or small cap stocks
These shares are generally defined by the price of their shares. The price you are talking about depends on the size of the country or the particular stock market. For example. those stocks that sell for less than $ 5 in the US or less than $ 1 in Australia.
Why do I avoid them? Mainly because they tend to exhibit low liquidity (low trading volume) and you may not be able to sell them whenever you want, or high volatility (price jumps a lot), or both!
Regulated markets and companies with competitive prices
I avoid companies that operate in regulated markets whenever possible, as they are always at the whim of the regulatory authority (commonly government bodies). They are in a dead end situation because if they are successful in making a decent profit, the regulator generally doesn’t like the idea, and you guessed it, they move to toughen regulations!
Competitively priced companies have a different problem. They have to be the cheapest business in their industry, and they generally don’t have an economic moat to protect them. They always have their competitors hot on their heels. Unless they can achieve large scale and can make it very costly for others to enter the market, they are continually under threat.
In summary
The benefit to me in excluding the above company categories from consideration of good stocks to buy is that the overall risk of choosing to invest in some of the remaining companies will be significantly reduced.
Reducing risk, while maintaining high returns, is the name of the game! The risk of loss is real: it can be minimized but not eliminated.
Being able to avoid risky companies like the ones above is one thing. But how do you go about choosing the most attractive investment stocks from the rest of the pack? Check out the links below to find out!
