gmsc’s money tips #16:

As promised in my previous money tips post, here are Peter Lynch’s rules for stocks to avoid. Again, this post is done in Peter Lynch’s own words.

If I could avoid a single stock, it would be the hottest stock in the hottest industry, the one that gets the most favorable publicity. Hot stocks can go up fast, usually out of sight of any of the known landmarks of value, but since there’s nothing but hope and thin air to support them, they fall just as quickly.

Beware the “next” something. Another stock I’d avoid is a stock in a company that’s been touted as the next IBM, the next McDonald’s, the next Intel, or the next Disney, etc. In my experience, the next of something almost never is – Broadway, the best-seller list, the National Basketball Association, or Wall Street.

Avoid diversfication. Instead of buying back shares or raising dividends, profitable companies often prefer to blow the money on foolish acquisitions. The dedicated diversifier seeks out merchandise that is (1) overpriced, and (2) completely beyond his or her realm of understanding. This ensures the losses will be maximized.

Beware the whisper stock. These are the long shots and the whiz-bang stories. Often the whisper companies are on the brink of solving the latest national problem, and the solution is either (a) very imaginative, or (b) impressively complicated.

What I try to remind myself is that if the prospects are so phenomenal, then this will be a fine investment next year and the year after that. You can get tenbaggers in companies that have already proven themselves. When in doubt, tune in later.

Beware the middleman. The company that sells 25 to 50% of its wares to a single customer is in a precarious situation. If the loss of one customer would be catastrophic to a supplier, I’d be wary of investing in this supplier.

Beware the stock with the exciting name. As often as a dull name in a good company keeps early buyers away, a flashy name in a mediocre company attracts investors and gives them a false sense of security.