9 types of companies you shouldn't invest in

Both experienced and novice investors try to carefully study the company before investing in it. This approach helps to avoid unnecessary risks and unexpected losses. Charlie Tian, ​​Ph.D. and founder of the value investing website, is also meticulously analyzing various firms.

In the book “Invest like a guru. How to increase profitability and reduce risk with value investing ”he compiled a list of signs that show that it is better not to invest in a company. With permission from Alpina Publisher, Lifehacker publishes an excerpt from Chapter 7. It just talks about troubled firms.

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In the stock market, it is very easy to lose a lot of money by buying rally stocks when the market is full of optimism and then selling them in times of downturn and panic. Either playing with stock options and futures, or buying on margin - if you do this, you can lose money on almost any stock.

Even if you are a long-term investor in a relatively peaceful growing market, you can still

lose money by buying stocks in companies that are on the road to collapse or that may survive but never reach the point where the price paid is justified.

Next, I will summarize the signs that may indicate that you are buying the wrong company. The warnings below are specific to the business of the company. If you spot one of these in the way the business of the company you are considering buying, think carefully about whether or not it is worth buying.

1. The company produces topical products with a stunning future

As a rule, it is young companies in "fashionable" industries. Their products are usually associated with revolutionary disruptive technologies that can have a huge impact on society. Many aspiring young entrepreneurs are starting companies in this field as technology promising and it is changing people's lives, and investors are delighted with bright prospects and are ready to invest in future technologies.

As technology advances, it becomes clear that it has truly changed people's lives. However, there are too many players on this field. Very few companies will make a profit and survive. Those who succeed will make a huge fortune for their investors, while most other investors will lose money because their companies will not be able to make a profit. And more investors will never make any meaningful income.

Novice and hobbyist investors can easily find themselves in a situation that I got into at the beginning of my journey. I bought shares in fiber companies because the technology was promising and the outlook was bright.

This technology has indeed made it possible to significantly increase the speed of the Internet and made it possible to use many applications such as streaming video, mobile Internet and online games, but due to too many companies, many of them never started to make a profit and did not justify their cost estimates.

This happens every few years in new areas, and now it happens more often than in the past, due to the acceleration of technology and innovation. In the last century, it was aircraft manufacturing, automobile manufacturing, semiconductors, digital clocks, computer hardware, software, the Internet, dot-coms, fiber optic technologies. In this century so far it is solar technology, biotechnology, social media, electric vehicles and so on.

Since the mid-2000s, with the support and encouragement of the US and Chinese governments, solar technology has flourished. The technology seemed promising because it is environmentally friendly and inexhaustible, and we seem to be running out of oil and gas.

The development of technology has led to a reduction in the cost of production and made it more cost-effective. This is a real revolution. Even Thomas Edison once said, “I would invest all my money in sun and solar energy. What a source of energy! Hopefully we will get hold of it before we run out of oil and coal. ”

Hundreds of solar cell companies have sprung up around the world, many of which have gone public, and this seemed to provide an excellent opportunity for investors to participate in the explosive development of new technologies. Investors inflated stock prices and made fortunes.

At that time, Shi Zhengrong, the founder of the Chinese company Suntech Power Holdings, became the richest man in China with a fortune of over two billion dollars, since Suntech shares were traded at New York stock exchange and its market capitalization was $ 12 billion. The market capitalization of US solar companies such as SunEdison, First Solar and SunPower Corp. has reached $ 10 billion.

However, the competition is very fierce, especially on an international scale.

As with any new technology, new investments were poured into solar energy, which increased competition; the technology developed rapidly and too many players began to produce far more products than the market could handle.

Solar panel prices have plummeted. Nobody benefited from this. Suntech Power and SunEdison have gone bankrupt. First Solar and SunPower have lost over 80% of their market value since 2008. SunPower is still suffering losses. SolarCity, a relatively new player in the installation of solar panels on rooftops and led by an entrepreneurvisionary Elon Musk (he is the chairman of the board of directors and the largest shareholder), cannot do it alone and is teaming up with another Musk company, Tesla Motors.

Tesla has its own problems. She, too, has never been profitable, and her losses are growing. She also works in the "fashion" industry, where more and more players are entering. Rumor has it that even Apple is planning to make machines. It looks like a fiber optic bubble from which I learned my painful lesson.

Do not misunderstand me. Solar energy did have a bright future. And it still is. It is becoming more cost effective and its market share is growing. As a former scientist and inventor, I am not against new technologies and innovations. New technologies and innovations make people's lives better. It's just not the best investment destination.

2. The company makes fashion products that everyone buys.

Remember the time when almost every child had crocs? Or does every teen have an Aeropostale T-shirt? They were cool and the kids loved them. In 2006, Crocs sales grew threefold from the previous year and doubled in 2007.

Aeropostale's sales grew more than 20% annually from 2004 to 2009. Parents bought not only children's shoes and T-shirts, but also promotions. Crocs has a market capitalization of over $ 6 billion. Aeropostale's market cap was approaching three billion.

But today these shoes seem ugly and no one wants to wear an AERO T-shirt on their chest. Crocs has been able to diversify and expand its range and sells more shoes today than before. However, its shares lost more than 80% of their value, and the market capitalization fell below a billion dollars. Aeropostale was so unable to become cool again and is close to bankruptcy.

It's okay to buy a stock of a company if you like its products, but it's worth making sure that the company is growing steadily and making a profit.

That is why, in our opinion, only a company that has been making a profit for at least 10 years can be considered good. We need to obtain confirmation that the company has been wealthy for at least one full market cycle. We do not want to succumb to the general excitement.

3. The company is at the peak of its cycle

Profits are high and stock prices seem low. However, it is actually a cyclical company that is at the peak of its cycle. Cyclical companies such as carmakers, airlines and durable goods manufacturers are making good profits at the peak of the cycle, which is why P / E ratio declines and stocks appear attractive to buy.

The P / C and P / B ratios, in comparison with historical data, more clearly represent the real value of the shares. If a company is a producer of commodities such as oil, coal, steel and gold, you also need to look at how their current prices compare to historical prices. If they are close to the historical peak, they are likely to fall.

We often hear stories of cyclical companies emerging from a crisis. This is usually not because their management is particularly gifted - the company is doing better simply because the market is recovering. When the recession hits again, management is likely to find that "it got the business going... but in the wrong direction."

We prefer not to buy cyclical companies, but if you are in the mood to buy, then the best time is at the low point of the cycle, when the news is bad and the companies may be losing money. Many of them cannot go through this stage and go bankrupt. Buy companies with high financial strength that can get through hard times. Also, remember to sell their shares when the situation looks good and the companies' profits are high again. In contrast to the consistently profitable cyclical companies, they will again face difficulties in the next downturn in the industry.

4. The company is growing too fast

You want the company you bought to grow, but not too fast. If it grows too fast, it may find it difficult to attract sufficiently qualified employees to maintain the level of quality of goods and services. This happened with Krispy Kreme in the early 2000s and Starbucks in the mid 2000s. Starbucks had to close over 900 unprofitable outlets and focus on its core business.

In addition, these companies sometimes need more funds than they can earn to finance their explosive growth, leading to a lack of cash and borrowing.

At the slightest problem in the economy or the company itself, there may be difficulties in servicing debt and the risk of bankruptcy.

Tesla is growing at a fast pace, with the Model 3 expected to be ready in three years. The company spends significant funds on increasing production capacity. In the meantime, by increasing the volume of car sales, she is losing more and more money. So far, Tesla shares are showing good dynamics for those investors who purchased them before 2013.

And don't forget that Tesla just bought SolarCity, which is running even worse cash from its explosive growth. Taking into account growth debt burden Tesla and its merger with a company in an even more difficult situation, I prefer to stay away from it.

Growing too fast is dangerous. When a company is growing too fast, keep an eye on its cash flow.

5. The company aggressively takes over other companies

Companies can grow by taking over other companies, which is even more dangerous. I can cite many examples of companies experiencing difficulties after a takeover. Because of the ambition of executives, many companies grow by taking over their competitors. They pay a high price to acquire them, and they become deeper in debt.

This happened with the Canadian pharmaceutical company Valeant. After Michael Pearson took over as CEO in 2010, Valeant pursued an active takeover policy. As a result of the annual takeover of several companies, its revenues grew from just under one billion dollars in 2009 to more than 10 billion in 2015. For quite some time, Valeant was the most popular company in the US and Canada.

Investors welcomed the rally and the share price rose more than 20 times. It was considered a merit of Pearson, and he was the highest paid CEO in the world. Meanwhile, the company's long-term debt rose from $ 380 million to $ 30 billion.

Then luck turned away, and the US Securities and Exchange Commission launched an investigation against the company. The takeover growth model failed and Pearson was removed from office. The share price is down 85% from its high, Valeant continues to lose money and the debt bomb is ticking.

If a company is overly aggressive on takeovers, keep an eye on its debt.

6. The company operates in an overly competitive environment

No company can avoid competition, which is why it needs to create economic growth based on high product quality, low costs, brand awareness, high switching costs, network effect and more like that. Different companies compete in different ways and at different scales. The restaurant usually competes with other restaurants in the same area. A tech company's competitors can be located anywhere in the world.

If a company sells similar goods, it cannot differentiate itself at the expense of products. She has to compete on price. The company wins with the lowest cost. Similar goods are oil, gas, agricultural products, air tickets and insurance. Over time, many high-tech products become homogeneous. Think of televisions and computers. Even smartphones are becoming homogeneous commodities today.

Retail is a very hard business because almost everything that is sold in one store can be found in another, and everything a company does can be easily replicated by competitors. Previously, the competition between retailers was local, but now it is global thanks to the Internet. Companies with higher costs do not survive and many are shutting down.

Do you still remember Circuit City, Sport Authority and K-Mart? The fiercest competition is among shopping centers, as there are too many of them. In 1977, Warren Buffett lostHuber J. A 1977 Warren Buffett Interview from the WSJ Archives money at Vornado Inc. He wrote: "As it turned out, there are too many stores, Vornado and the rest of the discounters could not withstand the competition from K-Mart stores." The K-Mart network is long gone, and the industry is just as congested as it was 40 years ago.

The reorientation of consumers to online shopping makes the position of shopping centers even more vulnerable. We continue to see players like JC Penney, Macy's and Sears fight. In an industry with such fierce competition, all players are losing.

7. The company goes to great lengths to gain market share

Consumer growth is not always good for a company. It should be selective with its customers and price its products in a way that is competitive but profitable. It is necessary to pay attention to loyal and paying consumers. Trying to gain more market share through aggressive pricing could threaten the company's survival.

Using any means to gain market share can have fatal consequences for financial institutions such as banks and insurance companies.

Negative effects usually only appear after a few years, so a rigorous assessment process is required. customers' solvency and proper pricing of products based on a correct assessment of possible losses.

Not so long ago, banks have loosened their solvency assessment standards and issued loans to low-quality borrowers who previously did not meet the requirements. They got involved in price wars and began offering loans with "zero collateral, at zero interest rates and with zero payments."

The financial crisis triggered by low-quality mortgages eventually set the world financial system is on the brink of collapse. The banks with the largest volumes of such loans have suffered the most. Many of them disappeared from the scene and were forgotten.

Insurance companies can have serious problems with too many clients and pricing that does not take into account possible risks. In the early 1970s, GEICO was on the verge of collapse as it sought to expand its market share. She was selling car insurance policies too cheaply. The company was on the verge of bankruptcy until it raised the price and left those states where it was unprofitable. These measures led to a decrease in its market share, but allowed it to become profitable again.

When I bought my first home, I insured it with Texas Select. With similar coverage, her insurance premiums were significantly lower than those of other insurers. However, in 2006 the company went bankrupt and I had to insure myself with another company at a higher price. Texas Select's low rate worked for a very small group of clients, and too aggressive pricing pushed the insurance company out of business.

In his letter to shareholders in 2004 Buffett namedBuffett W. Berkshire Hathaway shareholder letter, 2004 National Indemnity Company, a subsidiary of Berkshire Hathaway, was a "disciplined solvency evaluator" as it refused competing with the “most optimistic competitor” in pricing and was willing to lose customers in order to maintain profitability based on its solvency score clients.

If a company is trying to attract customers without paying attention to its bottom line, stay away from it.

8. The company faces a regulatory change

For many years, business education has been a privileged business because it allows get a college-level diploma for people who were unable to enroll in accredited colleges and universities. Revenue and profit in this area grew up for decades, and the stocks of commercial educational institutions performed some of the best results in the first decade of this century.

However, all of a sudden, everything changed. Graduates of such institutions could not find work and were bogged down in student loans. The government, which has poured billions of dollars in financial aid, has had to cover losses on student loans. An investigation into the activities of commercial educational institutions was initiated and a new law was passed that significantly limited their rights to enroll new students. The industry collapsed and shareholders suffered heavy losses.

Remember to analyze the regulatory risks of the companies you are planning to buy.

After financial crisis In 2008, new legislation was adopted to regulate the banking sector. Many sources of income have disappeared. Hospitals and health insurance companies have had to do business differently after the Barack Obama administration's Affordable Health Care Act was passed. In addition, these risks arise from investments in industries that are regulated by the state.

9. The company is becoming obsolete

Obsolescence of a company does not necessarily mean that it has been in the market for too many years. This means that it does not have time to adapt to industry changes. Its products are losing their attractiveness and are being replaced by new technologies.

Newspapers, once the main news providers and attracting advertisers, are now being replaced by the Internet. Blockbuster, with its traditional retail outlets where DVD rental was available, has been supplanted by Netflix. Kodak film has been replaced by digital cameras. Retail stores are gradually going online.

Canadian smartphone maker BlackBerry once dominated the corporate world with over 50% of the smartphone market. All executives in the corporate world had BlackBerry phones. Even I had two of their phones.

However, the company has been moving to touchscreen phones for far too long and has never really focused on building its ecosystem that raises switching costs for consumers. I remember a time when I couldn't remember the key combination on my BlackBerry phone for deleting blocks of email. Today, the smartphone market has forgotten about the BlackBerry.

The problem with aging companies is that they own a large number of assets - real estate, patents, brands, subsidiaries, and so on - and may look attractive to investors after a serious fall in the price of their shares. However, they are often the very same value traps in which investors lose most of their money.

Invest Like a Guru is a comprehensive guide to a value investing strategy. While the book will definitely be useful for beginners, it will also be useful for more experienced investors who want to find stocks with good performance.

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