When it comes to investing, choosing NOT to put your money somewhere can be just as important to your success. After all, one bad investment can easily water down the rest of your portfolio and cripple your returns.
Sometimes we need to ask ourselves, "W.W.W.B.D. - What Would Warren Buffett Do?"
While there's no way to know for sure the exact companies that you should avoid, there are certain guidelines that can help keep you on the right track.
Here's a list of things that you shouldn't be investing in:
1. Companies You Don't Understand
Investing in a company requires a deep level of understanding as to how that company operates, what their mission is, what their obstacles are, and more. Without this level of understanding, investing becomes speculation. And speculation is little more than gambling.
Imagine that you were considering buying 100% of a company. Wouldn't you want to know everything about that company you possibly could before you became its sole owner? That’s a huge investment and you wouldn’t want to sink all your money into something you’re not confident will succeed.
Regardless of whether you are buying 100% of a company or just a tiny fraction of it, the same level of scrutiny should apply -- this is still YOUR money and YOUR future.
Before you consider investing in a company, make sure you are completely familiar with the company and the industry it operates in.
Preferably, you will be at least somewhat familiar with these things before you ever even start researching a company. Any company that you are not deeply familiar with should be avoided.
2. Companies with Untrustworthy Management.
Even the best companies are only as good as the people leading them. Regardless of how many times it comes back to bite them, though, there will always be CEOs and other executives who cut corners, engage in shady business practices, and ultimately put their company in jeopardy.
At first, these companies may seem to be doing quite well. Until it all comes to a head, they may even be benefiting from their unethical leadership.
However, these practices never turn out well in the long run, and it's always the shareholders who suffer the most.
So how do you tell if a company has untrustworthy management?
Start by looking at their past record. Ideally, it'll be squeaky clean. If you do find that an executive has engaged in shady business practices in the past then it's a safe bet that they'll be tempted to do it again.
You'll also want to take the time to analyze a CEO's communication with the company's shareholders.
How upfront and honest have they been in the past?
Did they try to sugarcoat problems and hype up expectations higher than they should be or were they honest in the face of trials and success alike?
If a CEO sounds more like a salesman than an honest leader you should avoid their company like the plague.
Lastly, you'll want to look at a CEO's salary.
Is their compensation justified by their performance or are they drawing massive paychecks without pushing the company forward? Being paid large sums without producing positive results doesn't necessarily make a CEO untrustworthy, but it can make them complacent, which is almost just as bad for the shareholders of a company.
3. Companies That Aren't On Sale
If you've found an amazing company with great management that you understand and believe in then you are well on your way to making a sound investment.
It's absolutely essential, though, that you wait for the market to put that company on sale.
If it’s not there yet, stick it on your watchlist and keep an eye on it.
The margin of safety is there to help you avoid risk. If that company doesn’t do as well as you thought it would, at least you will have solace than you paid 50% less than you could have.
The good news is that prices go up and down, and if you're patient enough, great buying opportunities on excellent companies will come up. It's important, though, not to buy companies that aren't on sale.
So how do you determine if a company is on sale?
To calculate your margin of safety, I suggest you use my margin of safety calculator. I have a Margin of Safety Calculator here for you if you'd like it done for you.
How to Pick Rule #1 Stocks
5 simple steps to find, evaluate, and invest in wonderful companies.