Yesterday, I showed how investing for beginners doesn’t have to be as daunting as you might think. As someone who participates in our economy every day, there are lots of great companies you already know about. Many times, buying shares of these companies is a great investment decision.
Unfortunately, that won’t always be the case. Sometimes, our favorite companies have poor business models; other times, management can be corrupt; and worse yet, there are some companies that make money in ways that are very difficult to comprehend.
This is why “buy what you know” is a great place to start, but requires continual learning. Below are a few examples of companies that are relatively well known but might not be the best investing choices for beginners.
Pandora Media Inc (NYSE:P)
Who doesn’t love Pandora? I paid the $32 yearly fee for commercials to be taken out, and it’s on in my house for hours every day. It’s a company whose service I love, but beginners have to realize that there’s more than meets the eye.
Every time Pandora Media Inc (NYSE:P) plays a song, it has to pay a royalty fee for that song. That means that every song you listen to costs Pandora money. The only way to make up the difference is through advertising. As people listen to more and more music, advertising revenues need to keep pace.
So far, that doesn’t seem to be the case. In 2012, Pandora Media Inc (NYSE:P)’s revenue from advertisers grew 56%. That’s not bad at all. Unfortunately, the amount of money the company had to pay in royalty fees grew by 74%. That means that as Pandora got more popular, it was actually losing more money. That’s not the greatest business model when we’re focusing on investing for beginners.
Diamond Foods, Inc. (NASDAQ:DMND)
Though the name might not immediately sound familiar, Diamond Foods, Inc. (NASDAQ:DMND) is one of the leading providers of snacks in the United States. The company’s assorted nut snacks are sold under the “Diamond” name, but it also offers Kettle Brand potato chips, Emerald trail mixes, and Pop Secret popcorn.
That’s a relatively easy-to-understand business — but with Diamond Foods, Inc. (NASDAQ:DMND), there’s a catch. Management had been fudging their accounting numbers for quite a while to meet outsize expectations and to help extract huge bonuses. When investors found out, the stock plunged 70%.
This is the kind of risk that’s difficult for investing professionals, let alone beginners, to spot. It highlights the importance of continuing investing education as you grow more accustomed to your investments.
The vast majority of Americans use one of the country’s big four banks: JPMorgan Chase & Co. (NYSE:JPM), Bank of America Corp (NYSE:BAC), Citigroup Inc. (NYSE:C), and Wells Fargo & Co (NYSE:WFC). It’s easy enough to understand that a bank pays you interest to hold your money, lends that money out to others for a higher interest rate, and keeps the difference for itself.