To be a successful investor, it’s just as essential to avoid bad companies as it is to pick good ones. Unfortunately, it’s not always easy to identify bad businesses. Still, I think there are a couple of hallmarks that can identify poor investments. Here are five UK shares that appear to display these tell-tale signs, which I’d avoid.
UK shares to avoid
There are two red flags I believe are overwhelming indications a company’s a bad investment. These are a high level of debt and a lack of growth.
However, just because a company meets these negative criteria doesn’t necessarily mean it’ll turn out to be a bad investment. Indeed, highly leveraged UK shares can succeed, and businesses with falling profit margins can turn things around.
Nevertheless, I think it could be worth avoiding GlaxoSmithKline and Imperial Brands for these reasons. Both have high levels of debt and have been struggling to grow earnings in recent years.
Glaxo’s net debt has risen from £5bn to £14bn since 2015. Its operating profit has fallen from £11bn in 2015 to £8bn for 2020. Meanwhile, Imperial’s net profit has dipped from £1.7bn in 2015 to £1.5bn for 2020.
There’s another reason why I’d avoid Imperial, and that’s the company’s exposure to the tobacco sector.
These UK shares are taking action to try and reduce debt and increase profitability. There’s no guarantee they’ll be bad investments, but I’d avoid both shares according to my framework.
I’d also avoid Royal Dutch Shell. This company’s quite exposed to climate change issues, more so than other UK shares. Management’s plan to move away from fossil fuels is lacking. Moreover, the group’s debt has been increasing. If management can put together a new plan to speed up its energy transition, I may revisit the stock.
Pandemic casualties
Another company that falls into the bucket of the UK shares I’d avoid is Cineworld. This company’s debt has exploded over the past 12 months, and profits have been under pressure for years.
As the firm has binged on debt to increase its footprint worldwide, profit margins have come under pressure. I think it could be years before the group can rebuild itself to pre-Covid levels. That’s why I’d avoid the stock.
However, If earnings exceed expectations, the company may be able to reduce debt faster than my figures project. This may lead to a positive outcome for shareholders.
The final company I’d avoid is Restaurant Group. The owner of Frankie & Benny’s and Wagamama was forced to close most of its restaurant’s last year, and this hurt sales.
However, sales and profits have been under pressure for years. The firm has lost money in three of the past five years. Its net debt has risen from £32m to £824m in the six years since 2015. With these weak financials, I reckon it could be years before the group recovers.
On the other hand, it may outperform if consumers are quick to return to the firm’s eateries. This would allow it to reduce debt and invest in operations. On that basis, some investors might see this as a recovery play to hold in a basket of UK shares.
