Companies to avoid

People spend a lot of time discussing what companies to buy. But in the spirit of not losing money, it's equally worthwhile to understand the types of businesses that we investors should steer clear. At this moment, there are 5 main categories:

1. Businesses that rely on some fad or sexy growth stories and no cashflow.
Sometimes, share price of a company goes up because the management is touting a new technology or painting a rosy picture over their business prospects. Investors take in the stories and chase up the prices. In all cases, it will be wise for investors to dig for more information before commiting their money. Looking at the cashflow the company can generate is one of the trick. Personally, i will avoid if the company cannot have positive cashflow regardless how glowing the prospects are. These are growth stories without any substance. Also, after promising so much, if the financial results do not improve sufficiently, the share price will be dealt a crippling blow.

2. Businesses dependent on research
It's quite reasonable to believe that research can be a competitive advantage for certain companies. Nevertheless, there is an obvious downside to research. Often, innovative companies are required to do research simply to maintain their competitive position. And if the research dries up, the company suffers.
For instance, consider the plight of Creative. Early on, Creative has had impressive periods of earnings growth because of new breakthrough products and promising future developments. But since the bursting of the internet bubble, it has been on a downward spiral. The company has seen Mp3 player market share eroding in its ever present fight against Apple and earnings have suffered. Creative still produces fine products but the race to keep pace is costing shareholders money.
This is in stark contrast to a company like Diary Farm, which could develop nothing for a decade and still have a healthy business. While I don't think this is sufficient reason to sell off all your tech or biotech stocks, you can understand why certain legendary investors avoid such investments.

3. Debt-burdened companies
In general, one should avoid companies with a lot of debt. This makes sense. During the best of times, large amounts of debt mean that cash that could be put toward growing the business or rewarding shareholders is instead servicing the debt. In a crisis, debt greatly limits a company's options and can sometimes lead to bankruptcy.
A more subtle point is that great businesses throw off piles of cash. Great businesses generally don't need to use huge amounts of debt leverage to achieve an acceptable return for shareholders. So, if a company needs debt to achieve reasonable returns, it's less likely to be a great business.

4. Companies with questionable management
Management has incredible power as they often hold more than 50% of the stakes. If executives want to enrich themselves at the expense of shareholders, either directly or by misrepresenting the company's prospects, individual shareholders have almost no hope of stopping them. One should avoid companies where there's even a hint that management lacks integrity. Some clues to look for here include excessively optimistic press releases, overly generous compensation or options grants, and frequently blaming external circumstances for operational shortcomings.

5. Companies that require continued capital investment
Over the long term, shareholders make spectacular returns by buying businesses that are able to achieve extraordinary returns on capital. This leads to excess capital that the company can use to repurchase shares, pay a dividend to shareholders, or reinvest in further growth. Companies that constantly need to make additional capital investment to keep the business going are the antithesis of this ideal and the main beneficiaries will not be the shareholders.