What not to buy – Part 3: stocks to neglect

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For those following my postings so far, I’ve been showing you how I reduce the 500-strong universe of stocks on the Australian Stock Exchange down to the list that I follow – my watch list. By reducing all listed stocks to a manageable proportions, I can better follow and understand what my companies are up to.

Last fortnight, I got this list down to 68 stocks by focusing on the top 100 listed companies and eliminating all stocks from five sectors in which I don’t want to invest. Now, I’m going to eliminate certain types of stocks from within the sectors I like. And remember, we can axe ‘good’ companies without justifying our choices to the companies – it’s our money, not theirs!

Firstly, I eliminate any company with possible big downsides – compared with the possible upsides – due to regulation, oil price spikes, major changes in competition, natural disasters, recent company problems, and so forth.

So no airlines for me, however cheap. Leighton (ASX:LEI) goes because any company that has two CEOs and one chairman leave within a very short space of time might have another problem.

Of course, one day there will be a turnaround story for Leighton, and it could be tomorrow. But buying now? In my opinion, that’s a gamble rather than a well-timed long-term investment for my retirement savings.

No insurance companies for me, or anything that looks like an investment bank living off deals. No regional banks either.

Resource stocks constitute a big part of our ASX 200. But not all Materials stocks are in mining – that sector also includes building supply manufacturers, like CSR and James Hardie, and other sub sectors. But the two sectors of Energy and Materials together account for over one third of the ASX 200 index.

Within resources there are three types of companies: those that extract resources and sell them; those that have found or extracted resources, but are not yet quite in the position to sell them; and those who are hoping to find something to extract and then sell.

My retirement savings are not going to fund the speculators, and that includes research and development pharmaceutical stocks. If these companies are lucky enough to find something, they have a nasty habit of going back to the market for more money in the form of a capital raising. They may offer you one new share for each of a certain number that you hold at a price less than the market price. What this means is your original holding has been diluted. And they can keep coming back for more! You can keep losing money and they still might not make a commercially-sized discovery. And if they do, they still might not pay a dividend.

I also take the axe to a large part of Industrials. To my mind there are two major sub-groups in Industrials: those heavily exposed to the resources sector; and those that are not. I have a strong preference for the former – particularly with our dollar above parity.

Since I only want at most 25 stocks in my portfolio, the market capitalisation of the Industrials sector means there is no point in looking at more than three or four from that sector. So I don’t need to consider non-mining related companies in my universe.

The final cull comes from broker recommendations. If the consensus opinion is against a stock, I’m not going to stick my neck out on my own. But, of course, I’m happy to sidestep a stock they like. I don’t need all of the ‘good’ stocks – just enough of them.

Next fortnight I’ll write about how to use these recommendations and where to find them.

Missed a part of Ron Bewley’s Portfolio Building Series? You can find every column on Ron’s page on the Switzer Super Report website.

Woodhall Investment Research Pty Ltd

ABN 17 141 486 160

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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