Types of Stocks That You should Avoid: Successful stock investing requires a lot of discipline. There are thousands of stocks listed in Indian stock exchanges, and all you need to find is 10-15 good stocks to invest. For the remaining, you just need to say ‘NO’.
In this post, we are going to discuss four specific types of stocks that you should avoid investing in. However, before we discuss these four kinds, let’s first learn the most generic rule of stocks that you should avoid investing.
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Rule #1 of Stocks that you should avoid
“The difference between successful people and really successful people is that really successful people say no to almost everything.” -Warren Buffett
As an elementary rule, avoid investing in companies that you do not understand. If you can’t figure out how the company is generating its revenue, what is the company’s business model, what are the products/services offered by the company, or what is the use of the products- avoid investing in that company?
For example, if you have zero knowledge of semiconductors or microelectronics, and don’t understand the use of Zener diodes, MOSFETs, Amplifiers, etc. then avoid investing in semiconductor companies that manufacture these products. There’s no way that you can understand the market demand, product quality, future prospects, or even the competitors.
Instead, invest in companies that you can understand. A few common industries that anyone can understand with little efforts are Consumer goods, FMCG, automobiles, utility, etc.
4 Common Types of Stocks That You should Avoid Investing In
Here are four mainstream kinds of stocks that you should avoid investing to reduce the risks involved and safeguard your returns:
1. Low liquid Companies
There are some stocks whose prices may be continuously falling, but the investors are not able to sell that share just because there are no buyers. Exiting from a low-liquid company can be pretty stressful. Avoid investing in companies with low liquidity.
In general, stay away from companies with the daily average trading volume of fewer than ten lacks. The higher the volume, the better it is. (If you are new to this concept, try checking out the volumes of few of your favorite companies on moneycontrol or other financial websites to get a good idea of the daily trading volumes).
Besides, another way to check the liquidity of a company is by noticing the difference between Ask/Bid price. The smaller the difference, the higher is the liquidity.
2. High debt companies
Debts in the companies are like big holes in a ship. Until and unless, these holes are filled- the ship cannot go far. Avoid investing in companies with a lot of debt. As a thumb rule, keep away from investing in companies with a lot of debt in their balance sheet and debt/equity ratio greater than 1.
Also read: Is Debt always bad for a company?
3. Falling knife category companies:
Do not try to catch a falling knife! Investing in companies whose share prices are falling continuously and significantly (for example- Geetanjali gems, Yes Bank, PC Jewellers, PNB, Suzlon energy, etc.) is never a good idea. There’s always a reason why the prices of these stocks are continuously falling, and the market is punishing that company.
Moreover, there are thousands of listed companies in the Indian stock market which you can explore. Trying to catch a falling knife generally results in hurting your own hand if you are not trained on how to do so.
4. Low visibility companies
There are few companies in the Indian market whose information is not easily (and transparently) available on the internet or financial websites. This is mostly in the case of small and micro-cap companies.
Researching such companies with low visibility can be a tedious job for investors. Further, there are also chances of information manipulation if you can’t cross-check the data or when the reference sources are not reliable. Hence, avoid companies that are less visible.
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Bonus Tip (For beginners)
— Avoid investing in Penny stocks
Penny stocks are very risky to invest in. Many of the penny stocks become bankrupt and go out of the business. In addition, penny stocks are prone to different scams like pump and dump, etc.
There have been plenty of cases of price manipulations in penny stocks where the insiders try to inflate the share price. One can readily manipulate the penny stock prices by buying large quantities of these stocks. Besides, these stocks also have very low liquidity. Overall, if you are a beginner, it is recommended to avoid investing in penny stocks.
Anyways, if you’re inclined toward any penny stock company- then allocate only a small portion of your net investment (less than 10%) in that stock.
That’s all for this post. I hope it was helpful to you. Happy Investing.
Kritesh (Tweet here) is the Founder & CEO of Trade Brains & FinGrad. He is an NSE Certified Equity Fundamental Analyst with +7 Years of Experience in Share Market Investing. Kritesh frequently writes about Share Market Investing and IPOs and publishes his personal insights on the market.
