I just recently saw this article from The Motley Fool and thought it was worth reading. It talks about the types of bussinesses Warren Buffett avoids investing in.
Things to look for before you invest your hard earned money…
Businesses that bet the farm
In some industries, companies periodically have to make critically important decisions. If the company makes the wrong choice, it will be dealt a crippling blow. This is terrible for a shareholder, because even if the company makes the right decision one month, it might fail to do so the next. There is no “three strikes and you’re out” policy. One strike, and it’s game over — your money’s gone.
Businesses dependent on research
It’s quite reasonable to believe that research can be a competitive advantage for certain companies. In fact, one reason Medtronic (NYSE: MDT) has been so successful is that it has been able to continually develop new medical technology. Nevertheless, there is a 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.
Debt-burdened companies
In general, Buffett avoids 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.
Companies with questionable management
Management has incredible power. 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 preventing them. I strongly recommend avoiding 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, or frequently blaming external circumstances for operational shortcomings. WorldCom and Enron may have gone up for years, but at the end of the day, shareholders received almost nothing. That’s why I think questionable management is the worst flaw a company can have.
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 — the main beneficiaries will be employees, management, suppliers, and government. In other words, everyone except shareholders.
The full story along with explanations can be found at Fool.com.