QUALIPORT
Shares That Could Lose You Money

By Maynard Paton (TMFMayn)
January 22, 2001

Carburton Street, London -- The Motley Fool's mission is to educate, amuse and enrich the individual investor. Part of that process is through the running (and perfecting!) of various investment strategies, the Qualiport being one of them. While you'll occasionally see write-ups of possible Qualiport, Rule Shaker and Value companies, all the reviews do have an underlying theme -- there's a prospect of it being a "good investment".

However, trying to spot above-average investments is only one half of the battle for Foolish stock pickers. The other half is to know what to avoid. My colleague TMFEssex often quotes the following stock market adage.

"There are two rules in investment: Rule one, don't lose money. Rule two, don't forget rule one".

With that in mind, it's worth pointing out the types of companies that will often give most Fools investment heartache.

But note carefully the words "most Fools". I recognise there are all sorts of investors out there, be it chartists, value punters or those with specialised sector knowledge, who may be able to make money from the following groups of companies. And good luck to them. However, for those who broadly follow a Qualiport-type investment strategy of investing in great companies bought at attractive prices, the following businesses would be best avoided.

In reverse order of avoidance:

Overvalued

Perhaps this type of company is better phrased as Great Company, Bad Stock. Here's a snippet from TMFPanic's article:

"If you are buying some of the triple-digit multiple stocks out there today with the mind that they will make winning long-term investments, you are placing an inordinate amount of weight on the perception that your company is in fact a quality business of the highest order. In this kind of game, the odds that you have unearthed the Hope Diamond of business quality are firmly against you. Investing with an eye toward predicting the most improbable result as opposed to the most probable one is a dicey way to approach the market, to say the least."

In short, valuation matters. No matter how great the company's long-term prospects, if it's all factored into a triple-digit mutliple share price, you'll never make money. More often, you'll lose. As time goes on, so the chances of a newcomer pulling the rug from under a stock market darling become ever greater. This is especially true of companies involved in uncertain "hi-tech" areas.

Fashion

Investing in stock market fashions is bad idea from the start. Chasing everybody else into Internet stocks, football clubs or emerging markets is a sure-fire route to disaster. Needless to say, investing in fashion itself is just as perilous. The notoriously fickle clothing sector is another way of quickly losing your investment shirt.

The trouble with those operators associated with fashion is that they have no operating predictability, a must-have factor for long-term company investors. Remember, those flares that once sold for £50 may not shift for £5 if the fickle finger of fashion points the other way. The low barriers to entry and a mature and intense market give other reasons for investors to steer well clear. Whether it's the manufacturers, the designers or the retailers, creating long-term riches from the rag trade is an almost impossible task for the ordinary Fool. Click here to discover the sector perils in greater detail.

Difficult to understand

At least most Fools have a chance of understanding the product behind an over-rated company or the one involved in clothing. But getting involved in companies that are way off your radar screen is just asking for trouble. Favourites for this type of investment phenomenon are of a biotech or mining nature. But we're not really talking GlaxoSmithKline (LSE: GSK) or Rio Tinto (LSE: RIO) here, both concerns with identifiable products or reserves.

Instead, no end of novice investors prefer to punt on unknown companies, all embarked on quests to discover the cure for cancer or huge gold reserves in Darkest Peru. Businesses shrouded in mysterious terminology, operating way outside most investors' circle of competence, always attract the unwary Fool. Can you independently gauge the prospects of a speculative biotech or mining firm without total reliance on the views of the management? If not, trouble lurks.

Questionable Management

Finally, we come to the management. Now, all directors make the odd strategic blunder during their corporate life. Unfortunately, it can be difficult to decide whether the mistake was caused through bad luck or through bad judgement. However, making repeatedly bad operational judgements isn't the worst management sin.

Take Photo-Me International (LSE: PHTM). It transpired last year that the company had secretly overstated its operating results by including an exceptional gain, a gain that should normally be excluded from any operating profit calculation. At the same time as publishing the controversial results, the Chief Executive offloaded £28m-worth of shares. Nice timing, since that stake would only be worth £7m now. Would you feel comfortable with him still in charge? He still is, you know.

Or how about Wiggins (LSE: WGG), another company that has regular problems drawing up proper accounts? The group has been constantly in touch with the Financial Reporting Review Panel in recent months over the management's consistent inability to prudently report its financial health.

The anti-Qualiport

All in all, those groups of companies defy some of the Qualiport's long-standing investment beliefs. Amongst other characteristics, the Qualiport looks for companies that are:

* attractively priced;
* predictable;
* understandable, and;
* run by proven management.

And to round off, how about an anti-Qualiport portfolio? Here's a rough-and-ready portfolio that should give most followers of this portfolio the shivers. It will be interesting to see how this set of shares do against the real Qualiport in the years to come.

Company                   Current Share Price (p)


Telecity                                603
Fibernet                                880
Ted Baker                               320
Coats Viyella                            47
Cambridge Mineral Resource               27
KS Biomedix                             601
Photo-Me International                   77
Wiggins                                  30

Where Next?
Read these Foolish features:
* Great Company, Bad Stock
* The Danger of Overpaying
* Valuation Matters
* Rags to Riches? Unlikely...
* The Mining Promoter's Handbook
* Photo-Me in Focus
* Digging into Wiggins