Why a Great Company Isn’t Always a Great Investment

Daniel Penzing
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The Company Is Being Ignored by Wall Street

A decade ago, Amazon was struggling. It’d had a couple of bad quarters, its stock price was in the basement and Wall Street analysts were pushing the Amazon stock symbol to the lowest of the low-value businesses. Incomes were declining, margins were down and revenue growth had slowed.

But when Jeff Bezos took to the stage at last year’s Consumer Electronics Show, the world listened. Although Amazon’s stock wasn’t doing that well, Bezos was showing off a technology that he was sure would change the world. He was introducing the company’s first tablet, a device that was reminiscent of the iPhone in its early days with a near frictionless operating system from which customers could order any item at any time.

A Great Company Can Still Have an Excessive Valuation

Sometimes a great company isn’t a great investment, especially if it’s very expensive or you think the stock price already reflects the company’s greatness.

A great example of this is usually Apple, their stuff is superb, yes, but they are insanely expensive. Same with Google. A great company is not always a great investment.

Most of the time, investing is like betting on a horse.

You do your due diligence and pick the horse that you think is most likely to win.

This has a lot of similarities with financing. If you’re a good financier, you should choose a company that’s healthier than its competition and more likely to survive than its competition.

However, if a company is deemed to be more likely to win then we might say that it has a higher probability of winning than your favorites. That doesn’t make it a better investment, though.

At the end of the day, it’s always better to think of investing as gambling and not bet your entire life savings on one stock.

Profitability Doesn't Guarantee Stock Price Growth

To put it simply, there are many good investments out there, however, they aren’t always the best companies. Even with the most stable and profitable companies, there will almost always be better choices. A great investment is a company that will provide you a large return, has a history of growth and improvement, and a promising future.

It’s important to remember that a lot of the factors that go into determining if a stock is great investment or not can’t be fully grasped in the first few years. Of course, you will want to consider the historical performance of a company which can have an effect on future performance.

However, you also want to look at the management team and the fundamental product. If the data looks great now but the company management is not stable, then they may ruin your investment in a few years.

Finding a great investment means looking at companies with strong management and a positive future. So when choosing stocks look for top companies, rather than just companies with a high return on investment.

The best way to find out if a company is solid or not, is to do your research. What are their long-term goals, how are they going to accomplish them, and is the company currently positioned for success? Good companies learn from the past, adjust strategy based on market trends and opponent, and have a plan in mind for the future.

Good Companies Can Still Be Taken Down by Falling Markets

Many individual investors and retail traders will often look for attractive stock prospects and purchase them in order to keep a diverse portfolio. The concept behind this is that you want to buy a lot of different stocks in order to lower your risk.

If you diversify across a wide range of companies, industries, and countries, and then invest in the market at large, you lower the chance that any single investment will cause you to lose substantial amounts of money.

Every so often, you’ll come across a company that does so well that it seems like a great investment even if the market falls. It still makes sense to buy shares in this type of company, but you should be wary of investing in any one company.

If the company is a great one, it’s probably making products or services that are in very high demand. This means that it’s going to have to spend a lot of its time keeping up with the demand. If a company has this problem, it can still be a bad investment regardless of how strong its products are.

If a company becomes known for making goods or services that are always sold out, it will lose a lot of its ability to raise prices. It also means that its competitors will be forced to keep up with it and its executives will become obsessed with simply maintaining sales rather than growing.

Too Many Shares of Stock Outstanding

The most important thing about investing is to get into a good business. That’s easier said than done. In fact, it rarely happens. But it’s a principle that Wall Street should be preaching. When a company isn’t a good business, the stock will never be a good investment. But the converse isn’t always true.

There are many good businesses that don’t look so good on paper. And many good investments can’t be spotted from the 10-K. If you’re investing in a business, you need to know at least the basics. You need some form of inside knowledge, as well.

A company can be a great business and a great investment if it has a low ratio of stock outstanding. If it has a high number of shares outstanding, and if it has the growth of its business covered by things like debt, that’s a real problem.

The Company Is in a Declining Industry

No matter how great the company is, if it isn’t in a stable and growing industry it will likely be a bad investment. Industries are constantly changing and the right company in the right industry at the right time can make a lot of money. The problem is most great companies in a bad industry aren’t able to make money.

Great companies in a declining industry often try to innovate. Unfortunately, this innovation only brings additional cost, as well as makes it harder for the company to compete with companies in other faster growing industries.

The problem with innovation is it isn’t always successful. This is something tech companies are constantly trying to do. They’re always investing in research and development; but during that time they aren’t able to turn a profit. There’s a good chance that time and money spent on innovation will result in few, if any, positive results.

The Company May Potentially Be Facing a Scary Contingency

If a company is doing really well presently, but you don’t feel that there could be a major risk of it meeting a contingency in the future, then that probably isn’t the best investment.

Being able to identify these risks will help you to have a better diversified portfolio and will prevent you from entering into a sector that might experience a downturn.

Some companies haven’t been able to turn a profit even after few years. The reason is that the company, which you have invested in, is facing some serious issues. For example, you might have to close down a key division or lose out on a huge contract. These are things that need to be identified early.

If there is a major undertaking that is required, you are more than likely going to have to raise debt, and it is more than likely going to cost you. The company might be successful in paying down the debt, but if it doesn’t, then you are going to have to consider selling off your business and the revenue gained from it will be way below market value. This might result in you having to receive less than you were hoping for.

Final Thoughts on Why a Great Company Isn't Always a Great Investment

For some young investors, ordinary businesses can seem a little boring. Companies like Coca-Cola and Disney have been around for decades, and there doesn’t seem to be anything exciting about investing in a company that just turns out profits each quarter.

There are also a lot of new businesses with patents or products that people want to get their hands on. For example, Tesla is revolutionizing the way people get around. Or take Amazon, with its cutting-edge logistics.

But these new and innovative businesses don’t match the ideal investment profile that many investors look for, and they don’t settle well with people who are looking for high growth.

However, while a lot of young investors look for high growth companies, most of them don’t understand exactly what makes a stock a solid investment. A company can have a great price appreciation, but that doesn’t make it a great investment. Let’s take a look at some of the different characteristics of a great investment and why a great company is not always the best bet.