Here is your reference on sick business models and natures:
Penny Stocks – Penny stock investing considered as the most riskiest and dangerous investments today. Due to highly illiquid and uncertainty about the future of such companies, investing to penny stocks are similar to gambling with huge money. When someone buying penny stocks, there will not be any guarantee on his invested money or profit. The only certainty when investing on penny stocks are ‘the lose of invested capital always exists’. One who practicing value investing strategies should avoid penny stocks to invest in and even don’t look into such cheap businesses.
Commodity Type Business – With my previous articles, I have clearly informed the dangers associated with companies that have commodity type of business. Due to not having a monopolistic position in the market with any products but, presence of considerable number of competitors in the segment with similar products, makes any company vulnerable by forcing them to reduce the prices of their products to compete with others. If such happens, the profit between manufacturing cost and product price come to negative to bring the company to considerable debt. Such companies gradually fall to huge debt and finally come with heavy lose. Certainly, those who have invested on these companies will lose their capital to a great extend. The two important characteristics of commodity type businesses are, its huge and increasing debt and reports with irregular year to year earning numbers. Being a value investor, your first law should be identifying and avoiding businesses falling to commodity business category. Read this article for further reference
Business with huge or increasing debt – One of the golden value investing law is, never invest on any company that have huge unmanageable debts more than one and half of its yearly net profit. Consider this example; If an individual with lots of personal debts and not able to pay off the same using his present income, naturally he will look into another source for money to pay off his debts. This may finally lead him to borrow money from other sources and thus his debt base will increase further and gradually the situations worse more. Such situation certainly put him to deep trouble by not having enough money to meet day to day expenses of himself and family. By losing the financial rhythm, he finally go to bankruptcy.
Status of any company with bad debts, are not different from this scenario.If a company have huge bad debts and always struggling to pay off these debts, where would be the possibility to give profit to its investors? As a best practice, identify the debt part of any company before investing into it. Value investors should set an investing criteria on any company that have debt less than one year of its annual net profit or as a maximum of its one and half or less. Be alert when companies issuing additional shares to public or adding any of its businesses to parent companies, dropping any projects etc.. Remember, financial sector generally shows huge debt figures due to its business of lending money to public and organizations. Analyzing cash flow from financing activities can give more clear picture to understand the source of debt.
Hot and fast booming sectors – I am sure, most of us have not forgotten the huge market crash happened in US immediately after the internet business boom and related over investing activities to such companies. Those who had invested to such companies to be rich instantly, later went to bankruptcy due to huge lose and lost their own home too. As a value investor, one should always learn from experiences, to avoid any such mistakes himself in the future. In this context, never select and invest to any company from hot or fast booming sector. If I say by considering present situations, I am totally against to investing on real estate and construction businesses considering its weak fundamentals. Never commit the mistake of investing any companies by seeing temporary stock price hike. Instead, consider investing on companies with strong business models and strong fundamentals.
Companies frequently do acquisitions – Companies have habit of frequent acquisitions, must be avoided by a value investors by considering increase in debt base and the fund required from parent company to stabilize the business of new candidate. Generally company doing acquisitions with other who running in lose and have weak fundamentals. It add additional burden to the acquirer to pump enough fund from their profit to the new company. If you look into the report of any company who doing frequent acquisitions, you can realize the huge debt base. Avoid such. As a result, frequent new share issues and loans can happen and this the investors become huge losers. Avoid companies have habit if numerous acquisitions. Remember, most of the time the most looking ratios like PE ratio, will be attractive with such companies. This nature can mislead PE ratio savvy investors by assuming the company prices are attractive and lots of room available for profit.
Companies with huge cash flow from investing activities – Investing on any company have huge cash flow from investing activities, should be avoided by considering the huge operating expenses to maintain its business. Telecommunication companies are first in this list. They required to maintain all their assets, that required time to time maintenance for retaining operating efficiency, and spreading across locations. If operating expenses are high, naturally the profit margin will be less or none. If any company, from this category, concerned about investors money, they would be forced to get money by applying for new loans or cash from other sources. It could add their debt burden further and finally affect investors badly. As a value investor, one should know the operating expenses of the company to identify whether it is higher than expected or considerable low to add wealth to investors. Read this article for further reference
Regular new share issues public – Stay away from companies have practice of issuing new shares to public regularly. I have already point out all the bad effects of this bad habit from bad companies. Regular issuance of shares to public shows company not having sufficient fund to manage their business or have weak business model or in the debt trap. New issues not only reducing value of the shares investors have and also giving them huge lose later. Refer the article I have written on ‘How Stock Buy backs adding wealth to investors’ to get wonderful idea on this area.
Remember, more over knowledge to numerals or calculations, common sense plays major role to avoid big mistakes. Have a best practice of keeping an eye on actions from companies. Any such action have some intention behind it and that could affect to investors either directly or indirectly, as bad or as good. Identifying such, considering as a main task for a right value investor. Through using right sense, one can easily avoid huge mistakes.
As a reader, you might have similar ideas or queries on this article to express. If such, don’t hesitate to comment here or sending to me.