When looking for good stocks to buy using a longer-term value investing approach, I am immediately confronted with the multitude of companies listed on my stock market. I manage the task of how to buy good stocks by narrowing 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 reasons, it helps reduce the complexity of the task. Listed below are the classes of businesses that I generally rule out for the reasons described. By eliminating these companies, you will be more likely to minimize risk when choosing among 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 exchange 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 seeking additional capital to expand, but they can also involve larger private companies looking to go public.
IPOs can be a risky investment, as it’s hard to predict what a stock will do on its first day of trading and beyond. There is often little historical data to go on in order to analyze the company. The directors set the listing price that the investor must pay. He can be sure that they will set the price at a level that will ensure a good profit.
But will you make a profit? Don’t bet unless you can be sure there is a large group of punters who are hoping they can make a profit too and are enthusiastic enough to raise the price from the listing price.
sole recourse companies
They are companies that usually explore and develop mineral or oil resources. Companies that extract or explore for a resource are highly dependent on the price at which they can sell that resource, as long as they can market 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 venture. I prefer low risk companies!
capital intensive industries
They are companies that require large amounts of expensive equipment, machinery or aircraft to be able to trade. Consider steel mills, car manufacturers, and airlines, for example. Why do I usually avoid them?
Unless companies continue to pump 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 their share price. The price you are talking about depends on the size of the country or the particular stock market. For example. those shares 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 when you want, or high volatility (the price jumps a lot), or both!
Regulated Markets and Competitive Price Companies
Whenever possible, I avoid companies that operate in regulated markets, as they are always subject to the whim of the regulatory authority (commonly government bodies). They are in a no-win situation because if they manage to make a decent profit, the regulator usually doesn’t like the idea, and you guessed it, moves to tighten regulations!
Competitively priced companies have a different problem. They have to be the cheapest deal in their industry and usually 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 make it very expensive for others to enter the market, they are continually under threat.
In summary
For me, the benefit of excluding the above categories of companies from consideration as good stocks to buy is that the overall risk of choosing to invest in some of the remaining companies will be significantly reduced.
Risk reduction, while maintaining high return, is the name of the game! The risk of loss is real: it can be minimized but not eliminated.
Being able to avoid risky ventures like the above is one thing. But how do you choose the most popular investment stocks from the rest of the pack? Check out the links below to find out!