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Investing on commodity type business are a nightmare for value investors due to various reasons. It is very simple to identify a commodity type business if you try to identify some common factors that including or excluding a company to or from commodity type business. Why any value investor not interested or not to go for investing on commodity type business? Here are some important reasons to explore major disadvantages of commodity type business.
A commodity type business generally not have any business monopoly in the market with any of the product. It also leave lots of room for its competitors to come with various products or similar products. If such situations arises, generally competition will start and that result to reducing prices of products. As I have mentioned in my various articles, when there is competition happens, companies will not be able to sell its products to the right price.This will affect to the company profit and force to depends for debts.
Commodity type business are not able to beat inflation by raising or reducing price because of the existence of huge competitor base. This will be a major disadvantage for such business to fail or sunk to debt in the future. Investors thus lose there money to a great extend.
Identifying a commodity business is easy. Any business that have no consistency with per share earning for last 10 years, probably have a commodity type business. Such business generally have huge bad debts. Any company have a debt more than two times of its yearly net profit, should not be considered as a good value investments as per the strategy of legend investor Warren Buffett.
If you look into the cash flow of such companies, you can find the cash flow through financing activities will be high due to issuing new shares time to time for managing enough funds for business activities. This will further reduce the investors wealth to a great extend. Here is an article to know how stock buyback help investors to adding wealth to their investments.
Building an Intelligent investing strategy is the only possible solution to avoid such dilemma happening to investors. As I said in the previous article, reading to get right strategies and select the proper strategy as yours are the right methods.
Further read: Disadvantages of Monopoly Business !
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Sherin Dev is the founder and editor of Investinternals.com Blog. Learn more about him here. Follow him on Twitter @Moneyhacker or be in touch with him at Facebook
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