Avoiding the Worst Companies to Invest In can go a long way to helping you protect your portfolio. Even if you buy just one bad investment it can really hurt your portfolio. So naturally, the big question is…
“How do you avoid the worst companies to invest in?”
In this blog post we’ll find the worst companies to invest in…. and show you how you can avoid them! By looking at a few different criteria we’ll be able to easily find the worst companies for investment so you can confidently steer clear of them. Make sense?
Now let’s look at some of the most common ways to spot the worst companies to invest in…
Valuation Helps Avoid The Worst Companies to Invest In:
The easiest way to find and avoid the worst companies to invest in is by using financial statements to calculate an intrinsic value for the company. Most intelligent investors know that you should try to buy companies that are trading below their intrinsic value. And the truth is, when you focus on valuations you can almost always avoid the worst companies to invest in.
But it’s not a golden ticket answer. For example one common mistake value investors make looking for cheaply-valued companies to invest in is that they forget about growth. It sounds great to buy inventory for 50 cents on the dollar. But in reality it only works if you can sell that inventory at market value. So…
While looking for companies trading below book value is a great start, make sure there is some revenue on the income statement and a bit of a growth narrative to ensure capital can continue to be returned to shareholders.
Just keep in mind, while earnings growth is what investors like to see, too much of a good thing can still be dangerous. Read on to see what I mean.
The Worst Companies to Invest In Have Very High Earnings Expectations:
A lot of great companies that are growing fast can make some of the worst investment opportunities. Why’s that? Well…
It’s because even if companies are growing it doesn’t mean they will always return cash to shareholders. Instead, money is reinvested to drive growth, improve next quarter’s earnings and fend off competitors. And unfortunately….
If fast growing companies can’t keep up the hype of their exaggerated earnings, these high flying momentum stocks will collapse. And since the prices are so inflated these stocks have a really long way to fall. Just think of the dot com bubble if you’re looking for an example. So even though it sounds counter-intuitive, that’s why even companies with strong earnings growth can be the worst companies to invest in.
Now just for the sake of clarification…
Growing companies are definitely great. And steady earnings growth is something all investors want to see. But enterprising investors get into trouble though when they buy companies that have already raised earnings expectations multiple times in a row. So just be conscious of how earnings expectations align with reality.
Of course, if you do want to invest in a company but you’re afraid it’s over-valued or over-hyped you can protect yourself with diligent risk management. This is best done by avoiding over-sizing the position and use stop losses.
Protect Yourself From The Worst Companies to Invest in With Stop Losses:
One of the easiest way for traders or investors to avoid pain and protect their portfolio is using stop losses. So how does that work exactly?
Well I am hardly the first person to write about stock losses. But that’s because they work! So rather than reinvent the wheel I’ll refer you to Stan Weinstein’s Stop Loss Strategy. I found this approach to be incredibly actionable and it should really help you avoid investing in the worst companies. Sound good?
And By The Way: If you’re looking for more ideas to improve your approach to the stock market I encourage you to download my free ebook below. You’ll also get weekly email updates with the best tools and resources for individual and self-directed stock traders.