Both experienced and novice investors try to study a company carefully before investing in it. This approach helps to avoid unnecessary risks and unexpected losses. Charlie Tien, PhD and founder of the value investing website, also painstakingly analyses different companies.
It’s easy to lose a lot of money in the stock market by buying stocks on the upswing when the market is optimistic and then selling them in times of recession and panic. Or 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’re a long-term investor in a relatively peaceful rising market, you can still lose money by buying shares of companies that are on the road to collapse or that may survive but will never reach the point where the price paid is justified.
In this article, a writer from a cheap coursework writing service will tell you the signs that may indicate that you are buying from the wrong company. The warning signals described below relate to the company’s business. If you notice one of them in the manner of doing business with a company you are considering buying, think carefully about whether it is worth buying.
- The company produces a current product with an exciting future
These are typically young companies in “trendy” industries. Their products usually relate to revolutionary breakthrough technologies that can significantly impact society. Many ambitious young entrepreneurs start companies in this field because the technology is promising and life-changing, and investors are excited about the bright prospects and are willing to invest in the technology of the future.
As the technology develops, it is evident that it has indeed changed people’s lives. However, there are too many players in this field. Only a very few companies will make a profit and survive. Those who succeed will make a vast fortune for their investors, while most other investors will lose money because their companies will not be able to make a profit. And even more, investors will never make any meaningful income.
Beginning and amateur investors can easily fall into a situation I was in when I started. I bought shares in fibre optic companies because the technology and prospects were promising.
The technology increased internet speeds dramatically and made many applications such as video streaming, mobile internet, and online gaming possible. However, because there were too many companies, many of them never started to profit and failed to live up to their valuation.
This happens every few years in new areas, and it happens more often now than in the past due to the acceleration of technology and innovation. In the last century, it was aircraft, automotive, semiconductors, digital watches, computer hardware, software, internet, dotcoms, and fiber optic technology. In this century, it’s solar technology, biotechnology, social media, electric cars, etc.
- The company produces a trendy product that everyone buys
Remember the time when almost every kid had crocs? Or did every teenager have an Aeropostale T-shirt? They were excellent, and the kids loved them. 2006 Crocs sales tripled from the previous year and doubled in 2007.
Aeropostale sales grew more than 20 percent annually from 2004 to 2009. Parents bought not only children’s shoes and T-shirts but also stocks. Crocs had a market capitalization of over six billion dollars. Aeropostale’s market capitalization was approaching three billion.
But today, these shoes seem ugly, and no one wants to wear a t-shirt that says AERO on the chest. Crocs has been able to diversify and expand and today sells more shoes than ever. However, its shares have lost over 80% of their value, and its market capitalization has fallen below a billion dollars. Aeropostale has been unable to become cool again and is close to bankruptcy.
It’s fine to buy a company’s stock if you like its products, but it pays to make sure that this company is growing steadily and making a profit.
This is why only a company that has been profitable for at least ten years can be considered reasonable. We need confirmation that the company has been beneficial for at least one complete market cycle. We don’t want to give in to the hype.
- The company is at the peak of its cycle
Profits are high, and the stock price seems low. However, it is a cyclical company at the peak of its cycle. Cyclical companies such as automakers, airlines, and durable goods manufacturers make good profits at the cycle’s peak, causing the P/E ratio to drop and the stock to appear attractive.
P/S and P/B ratios, compared to historical data, more clearly represent the actual value of a stock. If the company produces commodities such as oil, coal, steel, and gold, you should also look at how their current prices compare to historical prices. If they are close to their historical peak, there is a high probability that they will fall.
We often hear stories of cyclical companies coming out of a crisis. Usually, it’s not because their management is exceptionally gifted – the company is doing better simply because the market is recovering. When the recession hits again, management will likely find that “they managed to turn the business around… but in the wrong direction.”
- The company is growing too fast
You want the company you buy to grow, but not too fast. If it grows too fast, it may need help attracting enough qualified employees to maintain the 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 non-profitable locations and focus on its core business.
In addition, these companies sometimes need more money than they can earn to fund rapid growth, leading to cash shortages and borrowing.
With the slightest economic problems, the company itself can have difficulty servicing debt and risk bankruptcy.
Tesla is increasing, with the Model 3 expected to be ready in three years. The company has been spending heavily to increase production capacity. Meanwhile, as it ramps up car sales, it is losing more and more money. So far, Tesla stock is performing well for those investors who bought it before 2013.
And remember that Tesla just bought SolarCity, which has an even more severe cash shortfall due to rapid growth. Given Tesla’s growing debt load and merger with a company in an even more difficult situation, I prefer to avoid it.
Growing too fast is dangerous. When a company grows too fast, watch its cash flow.
- The company is aggressively taking over other companies
Companies can grow by taking over other companies, which is even more dangerous. I can give you many examples of companies struggling after a takeover. Because of the ambition of the CEOs, many companies grow by taking over their competitors. They pay a high price for the acquisition and get deeper into debt.
This happened with the Canadian pharmaceutical company Valeant. After Michael Pearson became its CEO in 2010, Valeant embarked on an aggressive acquisition spree. As a result of annual takeovers of several companies, its revenue has grown from just under one billion dollars in 2009 to 10 billion-plus in 2015. Valeant was the most popular company in the U.S. and Canada for quite some time.
Investors welcomed the growth, and the stock price rose more than 20 times. This was considered a credit to 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, and the U.S. Securities and Exchange Commission launched an investigation against the company. The growth-by-acquisition model proved unsound, and Pearson was removed from his position. The stock price is down 85% from its peak, Valeant continues to lose money, and the debt bomb is ticking away.
If a company is pursuing an overly aggressive takeover policy, keep an eye on its debt.