The Thoughtful Investor
Stocks To Avoid
In this section, the author talks about stocks to avoid or companies that an investor should avoid or be cautious of even if it's soaring high in the bull market.
It is more important to avoid losers than to find winners, because a stock that has doubled in price must double again for the investor to break even.
The chances of making money are multiplied many times over with a focused company as opposed to one that runs multiple businesses under one roof.
Stocks to avoid:
- Growth achieved through repeated dilution of equity or debt. Companies which are fast growing with low ROE, low entry barriers and with negative cash flows, such companies fund growth through raising debt or through equity dilution.
- Diversification that isn't necessary. Ex: CESC’S entry into grocery retailing through Spencer’s was not welcomed by the author as it was an unrelated business. One should Avoid companies that continue to diversify into unrelated industries. It shifts management's attention away from the task at hand.
- Companies who make a lot of acquisitions as it is never cheap because it dilutes the ROCE when compared to the growth that the company generates on its own.
- Large market capitalization in comparison to the size of the sector. If the company's valuation rises much faster than the size of the total market opportunity, it's time to sell.
- Cyclicals that are performing excessively well. When the cycle is in full swing, cyclical stocks report record earnings and expansion plans and then aggressively expand, but when the cycle turns, they go into distress. The timing of the exit is critical in this case.
- Excessive showcasing. If the company's management interacts with the press too much, giving projections, it's best to avoid such companies. Companies that have no expectations generate great returns.