The Key to Successful Investing... Avoid the Junk

Editor's note: Finding good businesses is tough... and for good reason. As our Director of Research Matt Weinschenk warns, most businesses aren't nearly as profitable as you'd think. In this excerpt – adapted from the July 2024 issue of The Total Portfolio – Matt shares what most folks get wrong about corporate America today... and why it's critical to avoid all the junk in the market.

Business is a nightmare.

Misconceptions abound in this divided country... particularly when it comes to the business sector's role in American life.

Such divisions often break down along political lines. But on this particular issue, both liberals and conservatives love to turn big business into a boogeyman.

The left believes companies pursue profit at the expense of the environment or the disenfranchised. The right has problems with "wokeism" in corporate boardrooms.

They're united in the idea that businesses are profitable behemoths with shadowy ulterior motives...

They believe business leaders have omnipotent influence over our society... crushing rivals, corrupting lawmakers, exploiting resources and consumers, and laughing all the way to bank.

Now, it's true that there are some profitable, powerful companies. And maybe a few of them are evil. But that's not the standard.

Rather, I subscribe to the view that most businesses are held together by prayer and duct tape... with the threat of competition ready to rip them apart.

And the trick to successful investing is finding the few businesses that fit comfortably in the middle of those two extremes...

A survey run by the Reason-Rupe public opinion research project asked people what they thought the profit margin for the average company was after taxes. (The 2013 survey is a bit dated, but we haven't seen the question asked since.)

The average response: 36%!

If you've owned or run a business, you're no doubt cringing at that percentage because it's about triple the real one.

The average business in the U.S. sports a profit margin of just 8.7%, according to industry data from New York University's Aswath Damodaran.

The most profitable industry based on this measure – banking – generates 31% profit margins, which is still less than most respondents thought. One of the other most profitable – software – comes in around 20%.

And of course, companies in some industries are barely profitable at all. The average education-based company has profit margins of just 1.3% after taxes. And recreation has just a 0.9% margin. Still others lose money, like biotechnology drugs (negative 12% margins) and consumer electronics (negative 3% margins).

Not to mention, about 50% of businesses fail within five years, according to the U.S. Small Business Administration.

We also see this fallacy when big companies report earnings and skeptics quote absolute numbers.

For instance, someone will point out Disney's (DIS) huge profits of $5.7 billion for 2024 but fail to note that the company has nearly $200 billion in assets to generate that profit... making its return just 2.9%.

So while it could look to a superficial observer like Disney earns gobs of money, it's barely eking out a profit. And every time it raises the price of its streaming service or theme-park tickets, it's not trying to fleece unsuspecting customers... It's trying to maintain its dominant market position.

In the free market, competition waits at every turn. The second you fail to execute your plan, the next upstart could put you out of business. That's true for even the most dominant businesses.

You can see this by looking at the leading corporations by decade. No one lasts forever. A new generation of challengers always comes up...

When a mega corporation tries to improve margins or lock in customers with "anticompetitive" practices, it's often done as much out of fear as greed.

Being in business is hard. The same competition that allows you to thrive allows someone else to take you down.

And that's what's fun about investing... because as an investor, the rise and fall of these companies is what allows you to profit.

I've worked at Stansberry Research for more than a decade, contributing to some of our most financially conservative advisories. And I pride myself on being a skeptical investor.

Almost any time someone asks me about a stock, my honest answer is, "It's probably no good."

That should be your default position on any investment, until proven otherwise.

There's a lot of junk out there.

Most stocks just putter along or lose money. Only a few key winners drive the stock market returns that investors enjoy.

Most businesses struggle to stay ahead of competition, ahead of inflation, and ahead of margins that are hard to build up and even harder to maintain.

One 2023 study assessing the performance of 28,114 firms from 1926 to 2022 determined that 58.6% of stocks reduced investor wealth. Just 50 firms accounted for more than 43% of the total wealth created.

That's not to say stocks aren't worth it. (Shareholders did earn $55 trillion in wealth overall during the period.)

It just means you need to find the good ones.

So, be selective. If you don't see a good opportunity, wait and do the research until one appears... Your portfolio will thank you.

Good investing,

Matt Weinschenk

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