Buy Winning Companies not Losing Ones

Now come on… how many of you look at the top percentage losers on ADVFN's top lists every day to try and find big fallers?

Yes, lots of you. Why? Because you want to find the biggest loser and try and play the bounce. This is a dangerous game. You may win big once or even twice, but - over time - this is a losing game.

Buy winning companies, not losing ones. Playing the dead cat bounce game is something every investor, at some point, does - and then ends up realising they're on the road to nowhere.

What's worse is if you start your investing career by playing this game and winning at the start. Like a gambler, that win will make you far too confident and you'll play the next dead cat bounce with more money. And that'll be the one that ends up crashing.

The reason I mention all this is because I got a letter from a reader of my website:

"I thought it might be prudent to invest in companies that had lost pretty much everything. I've always thought stocks issuing a profit warning, or an amazing downturn in operations may be a good opportunity, due to overselling.

"Following this, I mentioned to a few colleagues on Thursday evening that they should invest in Elcom International. I should mention that I was unable to invest because I'd spent the majority of my portfolio purchasing a new flat for myself and my ever (non) thankful girlfriend - how thankful I am?! Either way, by 4.30pm, ELCS was up 180%! I've never seen this reaction - but then, I've not been monitoring these stocks for more that a week. I'm guessing this is a fluke? What are your thoughts? I'm not playing more than £1,000 on these, so it's not going to rock our world, but I'd be interested."

The first line of this letter pretty much sums up the biggest mistake new investors can make.

My view - NO! It is NOT prudent to invest in companies that have lost pretty much everything. And I'm sure Mr Prudence himself, Gordon Brown, would agree! It's actually much more prudent to do the exact opposite - invest in companies that are gaining market share, increasing profits and turnover.

Going back to the Elcom example, the 180% per cent may not be as good as it seems. The spread on the share can be 30-40% and you'd have been very lucky to have bought anywhere near the bottom.

In any event, my message to this reader is this: stop looking and buying these types of shares right now before you start losing heavily. Stop trying to find the biggest fallers and concentrate on good value winning stocks. That way, over time, you'll make money rather than being up 20% for one day and down 40% the next.

This is not investing - it is, to be brutally frank, lazy gambling.

This last week has seen a good comeback for small and mid cap shares that took a battering before Easter. There is plenty of value left in the market and my three most recent value plays are all going very nicely: Telecom Plus, Costain and VP Group.

Post election, things might start to look different. For the moment, there are still bargains out there.