How to avoid bad investments?

Picking winning shares is something every investor naturally wants to do.

However, success in investing is just as much about avoiding bad investments and minimising the risks that you take with your money.

Investors spend too much time thinking about how much money they can potentially make from owning a share and not enough time thinking about how much money they could lose if things go wrong.

Avoiding bad investments is important because they are hard to recover from.  If you lose 50% of your money invested, you need to find an investment that will double in value just to get the value of your portfolio back to where it started.

The more bad investment you can avoid, the better your long-term investment performance is likely to be.



How do you stay away from bad investments?


1.   The first thing to do is to focus your investments on quality companies with the following characteristics:

• A consistent track record of increasing sales and profits.
• High returns on capital employed (ROCE).
• An ability to turn a high proportion of profits into free cash flow.

2.  Arguably, the biggest danger that shareholders face when investing in a business is the company's debt.  

The investor must learn how to analyse a company's debts and to distinguish between safe and dangerous companies.  

This will help the investor to stay away from risky investments that have the potential to damage his/her wealth.