Common Types of Stocks to Avoid Investing In
The NSE and BSE, India’s two primary stock exchanges, boast a combined total of over 6,800 listed companies. Given the variety of stocks traded daily, it is understandable that investors may become overwhelmed.
Familiarizing oneself with various stock categories is advisable. It’s even more critical to recognize which types of stocks to steer clear of.
In this blog, we will explore some types of companies investors might want to avoid investing in.
What Types of Companies Should You Avoid Investing In?
Low Visibility Companies
When you own stocks, you own a portion of a company. Hence it becomes necessary to understand the company’s business practices, the effectiveness of its methods, and its performance over time.
Identifying specific details about companies can be difficult, particularly for those known as low-visibility companies. Researching them can be time-consuming, and the information gathered may be erroneous, as manipulators intentionally create inaccuracies.
Even if a low-visibility company is performing well, it may still have low trading volumes, leading to being overlooked. We will further explore why low-trading volume stocks are considered unfavourable in the subsequent section of this article.
High Debt Companies
Companies often utilize debt as a means of acquiring funds for daily operations or acquiring assets. However, when debt becomes unmanageable, it can result in significant problems as interest payments become burdensome.
Companies with a high debt to equity ratio frequently encounter difficulties repaying debts, especially during an economic downturn, once they reach a specific threshold.
To determine whether a company is among the high-debt companies in India, investors should examine the debt to equity ratio or the debt to liability ratio. Additionally, it is helpful to compare the average debt levels for the specific sector in India where the company operates.
You can consult websites and portals such as ETMarkets, Moneycontrol, and others to identify companies with the highest debt in India.
Falling Knife Category Companies
Attempting to catch a falling knife can be dangerous and potentially harmful. Falling knife companies refer to those experiencing a significant decline in their stock prices. While some investors may be enticed to purchase these stocks at a discounted rate, it is impossible to predict how long the fall will last or when the stock will rebound.
Investors who purchase stocks that continue to fall after a rapid decline may suffer losses. Additionally, as share prices fall, potential buyers may become hesitant to invest, leading to decreased demand and further price decreases for the stock.
Avoiding “strategies” such as buy-the-dip, which involve purchasing stocks at low points, is not advisable. This is because it can be challenging to determine when a stock has reached its lowest point and may continue to decline even after showing brief signs of improvement.
Low Liquidity Companies
Liquid assets are those which can be readily converted into cash without losing their value. A company is considered to have high liquidity if it holds a significant proportion of liquid assets. On the other hand, companies with low liquidity may have to rely on external debt to meet their debt obligations, which can be risky.
Dependence on external debt to meet debt obligations can create a slippery slope. Companies with low liquidity are more likely to be caught in a debt spiral than those with high liquidity.
Are Low Liquidity Stocks The Same As Low Liquidity Companies?
Low liquidity stocks and low liquidity companies are two distinct concepts. The liquidity of a stock refers to its ease of buying or selling on the exchange without causing significant fluctuations in the stock price. Stocks with low trading volumes are known as low liquidity stocks.
Investors may face difficulties selling off low liquidity stocks, particularly when prices start falling, making it challenging to cut losses.
Consequently, low liquidity companies and low liquidity stocks are generally considered undesirable.
Final Thoughts
Investors should be wary of particular stocks to avoid in the market. For example, low visibility stocks may be challenging to research thoroughly, while high debt companies may need help maintaining profitability and paying dividends.
Attempting to buy stocks in the falling knife category can result in significant losses, and low liquidity companies may need to increase their debt load. By identifying and avoiding these types of companies, investors can potentially avoid incurring substantial losses.
FAQs
Government bonds are perceived as being less risky than equities or corporate bonds. In particular, inflation-indexed bonds (IIBs) are attractive for investors seeking stable, inflation-proof returns. These bonds are adjusted for inflation and issued by governments.
Penny stocks are widely considered high-risk investments due to various factors, including limited historical data, a lack of information, and low liquidity. Additionally, penny stocks with a low market capitalization may be more susceptible to price manipulation by unscrupulous individuals seeking to take advantage of their vulnerability.
One should start by familiarizing themselves with a range of do’s and don’ts. This includes learning how to conduct primary fundamental and technical analysis. By acquiring these essential skills and knowledge, novice investors can set themselves up for success in investing.
Stocks that exhibit a combination of high debt to equity ratio, low visibility of future profits, low liquidity, and a sharp decline in their current value are considered riskiest. Such stocks may carry a higher risk of financial instability and may be more susceptible to significant losses for investors.
