Why New Investors Should Avoid New Companies
Initiation to the world of investing can be a painful experience if you are going at it alone.
To be fair, there is a lot to learn. Without guidance, things can get overwhelming in a hurry.
I know this from personal experience.
It wasn’t until eight or nine months into my DIY investing career that I really started to feel like I knew what I was doing. Even then, I knew that my stock market education was only beginning - But I knew I was headed in the right direction.
If you’re a new investor or thinking about trying your hand in the stock market, then this one’s for you.
When All Else Fails Just Following The Money
In this article, I’m going to breakdown one common mistake that plagues inexperienced investors.
Buying companies that don’t make money.
If you can dodge this bullet you will do yourself a massive favour.
So, without further ado…
Why I Don’t Invest In New Companies
Investing is more art than science.
No matter how much you weigh the risks and rewards, no one can say for sure what will happen with a particular investment.
It’s impossible.
All we can do is make an educated guess based on the information available.
This is my first beef with investing in start-ups.
As promising as they may seem, new companies simply lack the data points needed to be properly analyzed.
A Brief Intro To Fundamental Analysis
Do your research!
Before buying into a company, experienced investors always run the number. That means digging up the income statements, cash flow statements, and balances sheets of the business in question.
Collectively, these documents are known as “Financial Statements”.
Combing through financial statements can feel like picking up a calculus textbook and trying to read it cover to cover 😒
But, when the data are distilled down and made digestible we can use them to get a better understanding of the company’s health and performance.
This process of searching through financial statements is called “Fundamental Analysis”.
Fundamental analysis attempts to identify important performance trends, competitive advantages, and management strategies that make a business attractive or avoidable.
Let’s look at an example…
Why Everybody Loves AAPL
There is a laundry list of reasons why people love the international tech giant Apple Inc. (ticker symbol AAPL).
Their brand has become synonymous with innovation and it seems like every person in the developed world owns at least one of their products.
But what does that popularity equate to from a business standpoint?
Here are some statistics that make AAPL an attractive company to own:
10-Year EPS Growth (TTM): +498.18% ($0.55 to $3.29)
5-Year EPS Growth (TTM): +42.42% ($2.31 to 3.29)
1-Year EPS Growth (TTM): +10.03% ($2.99 to $3.29)
Return on Equity: 73.69%
Return on Assets: 12.51%
Dividend Growth Rate: +5.13%
Net Profit Margin: 20.91%
Free Cash Flow $60.39B
Financial statistics like the ones above tell investors exactly what kind of growth a company has been able to accomplish in the past.
A track record for success makes investors more confident in the future of a business because that business has already demonstrated that they know what they are doing.
In other words, people like Apple for 3 main reasons:
They make money now
They have made money for a long time, &
They look like they will continue to make money in the future.
Younger companies, on the other hand, just don’t have enough of a track record for us to make these same claims.
The data simply isn’t there to analyze!
This doesn’t mean that new companies are bound to fail. It doesn’t mean that start-ups intentionally mislead investors with optimistic growth and earnings estimates.
All I’m saying is that a lack of information breeds uncertainty.
As a new investor, why would you bet on a company that has barely put any stats on the scoresheet?
Trust me, there are better options out there.
Look For Strong Profitability
At its core, investing is about taking an ownership stake in real life business. Never forget that.
This isn’t gambling on ticker symbols or brand names.
When you buy shares you become an owner. Because you are an owner, you are entitled to share in the future growth and profits that your company generates.
Keeping this in mind, it can only make sense that the best investments are companies that are both growing AND profitable.
Why The Fastest Growing Companies Lose Money
Young companies experiencing rapid growth have to spend most (if not all) of their revenue on expansion.
5 profit killing costs that make earnings scarce for growth-focused start-ups.
Research related to new and improved products is expensive.
Manufacturing those products, either in-house or via third party suppliers is expensive.
Marketing to build brand awareness is a gigantic cost, especially when trying to escape obscurity.
Distribution - These days customers demand fast, easy access to the products they want.
Sales is the lifeblood of every business and foot soldiers don’t work for free.
All of this spending is needed to grow the business, but it comes at a cost.
Most of the hot new companies with the highest growth potential actually lose money every year.
But, 🤨 losing money - That’s not our style.
How The Best Companies Increase Sales and Increase Profits
When you’re first starting out, look for well-established businesses that are able to use economies of scale to their advantage.
Economies of Scale: When you can reduce your cost of production because you are making a larger volume of goods.
Big businesses have proven products that people know and love. They know what people want which eliminates a lot of the questions that new companies still have to ask. This helps them save on research and marketing.
A great product that is gaining popularity equates to increased sales numbers.
More Sales = More Revenue.
As mature companies move more units (that’s “cool talk” for sell more products), they eventually find better ways to optimize their supply chain and build more efficiency into the production of their goods. This leads to massive cost savings over time.
If a company can spend less to produce each product, naturally, there will be more money to keep after it is sold.
Higher Efficiency = More Profit.
When you’re researching companies, make sure to look at the trends. A skilled investor will only buy companies with increasing sales & improving profitability.
Wealth For The Long Run
Investing is a marathon.
Your financial legacy will not be solidified overnight, so don’t expect to get rich quick.
If you are trying to build a better future for you and your family then you only need three things.
Clarity. Write down WHY you are investing and let that goal guide your financial decisions.
Strategy. You can’t win a long-term game running plays from a short-term playbook. Invest in your financial education & find good help.
Commitment. Your plan is only as good as your ability to stick to it. Make sure that you set yourself up for success and keep your goals top of mind.
Start out by building a solid base before you fill your portfolio with more speculative stocks.
There are great deals to be found all the time. The stock market isn’t going anywhere.
✌🏾 Thanks for reading