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1 Ugly Truth About The Stock Market And How You Can Protect Yourself From It

Here’s an ugly truth about the stock market: It’s very easy to suffer debilitating losses from investing in the wrong companies. How easy?

According to a study done by J.P. Morgan, 40% of all stocks in the Russell 3000 universe (the Russell 3000 is a broad-based stock market index in the U.S. comprising of thousands of companies) from 1980 to 2014 had delivered negative returns over their entire lifetimes as publicly-listed entities. Also, 40% of all stocks in the same universe have suffered a permanent decline of 70% or more from their peak values.

Given how easy it can be to step on landmines in the stock market, it thus pays to carefully consider what you might want to stay clear of when investing.

This is where advice from billionaire investor Warren Buffett can help. Buffett, who has amassed a superb 50-year track record of investing excellence, gave investors a good description of one type of business to avoid in his 2007 Berkshire Hathaway Annual Shareholder’s Letter:

“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk [the site in which the first controlled powered airplane flight took place], he would have done his successors a huge favour by shooting Orville down.”

Some Singapore-listed firms which (rather unfortunately) may fit the bill include Ezra Holdings Limited (SGX: 5DN), Golden Agri-Resources Ltd (SGX: E5H), and Noble Group Limited (SGX: N21). The following table (click for larger image) contains some relevant statistics to support my view:

Table for Ezra, Golden Agri, and Noble

Source: S&P Capital IQ

As you can see, all three firms had spent billions on capital expenditures over the timeframe we’re looking at in order to help drive their great revenue growth. But, all that growth had mostly been for naught judging from how their profits had all shrank considerably.

Their poor business performances have not gone unnoticed. Since the start of 2010, Ezra, Golden Agri, and Noble have seen their share prices drop by 87%, 19%, and 66% respectively. Those are horrible returns when we consider that the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking Singapore’s market barometer the Straits Times Index (SGX: ^STI) – had gained 14% over the same time period.

A Fool’s take

None of the above is meant to say that Ezra, Golden Agri, and Noble would necessarily be lousy investments in the future. But, given what we’ve seen with their history, investors who are interested in them today would need to proceed with caution and be mindful of the risks involved.

The stock market can be a treacherous place if one’s not careful. To protect ourselves from its dangers, we can take cues from Buffett’s wisdom and give a wide berth to any company which “grows rapidly, requires significant capital to engender the growth, and then earns little or no money.”

For more investing analyses and important updates about the stock market, sign up for The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathaway.