4 Traits to Avoid When Investing

Legendary investor Peter Lynch is one of the most recognisable names in the investment world. Not only is he an astute investor, he also wrote several books on investments and spends much of his retirement time on philanthropy.

Even though his books were written over two decades ago, most of his investment principles still apply today. Besides giving investors advice on the traits he found favourable in companies, he also highlighted four company traits could be red flags to investors.

In this article, I will discuss what these four traits are and why we should be wary of investing in companies that possess them.

Unfavourable trait 1: Hot stocks in hot industries

Lynch believed in finding bargain stocks. As such, stocks that are “hot” would not be enticing to him. This is because these stocks usually trade at a premium because of the hype that surrounds them.

Instead, Lynch preferred to find stocks that were under the radar and could be bought more cheaply than the so-called “hot” stocks.

Unfavourable trait 2: Companies with big plans that are not yet proven

How many times have we heard of “hot tips” from our brokers or friends who believe they have stumbled on an investment gem? These companies that people recommend are usually small-cap companies that have big but unproven plans.

Lynch was extremely cautious when it came to such companies as their plans could just as easily fall through. Due to the hype surrounding such companies, they may also trade at a much higher valuation than others, making them a more risky investment.

Unfavourable trait 3: Profitable companies engaging in diversified acquisitions

Lynch used the term “diworsification” to describe companies that engaged in activities that are very different from their core operations. From his experience, he noticed that these acquisitions did more harm than good to most companies.

There are a few reasons for this. First, the current management team may not have the expertise to oversee a business that operates in a different industry. Moreover, the company that is acquired may not be as profitable as the first, or may even be loss-making, reducing the overall profitability of the business.

Unfavourable trait 4: Companies in which one customer accounts for more than 25% of their sales

A company should not be over-reliant on a single customer for business. Besides having a diversified customer base, it is also important that companies have multiple revenue streams and have business from different geographical locations.

The Foolish bottom line

Lynch was a master at finding strong growth companies that could withstand the test of time. Besides being an astute stock picker, he also knew exactly which stocks to avoid. Hopefully, by being aware of these four unfavourable traits, we can all be better investors.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.