Avoiding bad stocks

Not only is Edge Seven’s value investing methodology great for investing in the best stocks, it is just as importantly helping people to avoid buying the worst stocks.

I am frequently asked ‘Is there a way to avoid buying shares in the Centro’s, ABC Learning Centre’s, Babcock and Browns of our stock market?’

Yes, there is!!

Edge Seven’s methodology of value investing helps avoid the worst stocks and helps you to choose to be invested in the best stocks.

Edge Seven’s value investing methodology involves a process of calculating the changes in cash-flow and debt levels of businesses from one year to the next. Why is that important?

Changes in cash-flow
In Edge Seven’s value investing process, it is very easy to spot a business that reports an excellent Net Profit after Tax but does not have the cash profit (cash-flow) in the bank that reflects the reported profit. A business that runs out of cash often will have to borrow more money or raise capital from shareholders in order to keep the business going. The net effect of borrowing or raising capital is a reduction in the value of the business.

Change in Debt levels
With Edge Seven’s process, it is just as easy to see if a company has increased or decreased its debt level from one year to the next. Even some good businesses have increased their debt levels in recent times, including Woolworths (WOW), The Reject Shop (TRS), McMillan Shakespeare (MMS) and JB Hi Fi (JBH). While the debt levels of these businesses are sustainable, it does highlight that the performance of the business has changed and often not for the better.

Avoid the worst stocks
Edge Seven Value Investing helps you avoid the stocks with unsustainable debt levels and poor cash-flow. ABC Learning Centre collapsed because it took on over a billion dollars of debt in order to grow profits. Sure profits grew, but not enough to cover the ongoing cost of the debt. So while the media reported higher profits at the time, unfortunately that was only half the story. The business actually had lower profitability and eventually collapsed under the weight of its debt.

By avoiding the worst stocks (ie the 1,100 odd businesses out of 2,000 listed on the ASX that did not make a profit last year), this alone can help you beat the market. By avoiding the very worst stocks that inevitably will collapse, you will help yourself minimize loss of capital invested in that particular stock.

Value Investing provides the twin benefit of highlighting the best stocks that I want to be a part-owner of and it shows the stocks that I definitely do not want to own.

Are you avoiding the worst stocks and buying the best stocks so that you can make money for yourself and/or your Self Managed Super Fund (SMSF)?

This article is published by Dean Mico.

The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

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