The S&P/ASX 200 (INDEX: ^AXJO)(ASX: XJO) is filled with shares I wouldn't buy, like Ardent Leisure Group (ASX: AAD) and Qantas Airways Limited (ASX: QAN).
A rule of thumb
Buying shares is not rocket science. In fact, it's not even a science at all — it's an art. Mostly, a negative art. Meaning, if you can just avoid losing money you'll improve your chances of coming out ahead of the pack by a long shot. But with over 2,000 shares on the ASX, it's hard to know which shares you should avoid.
To make the process easier, some professional investors use a 'heuristic' to help them make a decision about a company. A heuristic is a fancy word for a 'rule of thumb'. We all use rules of thumb to make everyday decisions. We develop more as time goes by.
For example, if you have ever watched an episode of Sky Business on Foxtel you will notice that the panel of finance experts have become numb to getting asked by callers about (mostly) terrible ASX shares that no-one has heard of.
Caller: "Hello panel. Should I buy shares in this terrible gold mining business that no-one knows? Cheers, Greg from Timbuktu."
The expert panellist might fumble their sentences and bumble around for a moment before concluding that they don't know a lot about the business, yet it sounds like a business that is not worth the caller's time.
They might offer some guidance, such as, "You must be careful with businesses of this sort because of XYZ".
The expert couldn't possibly know all 2,000 shares on the ASX, so they use a rule of thumb to perturb the caller from gambling their money on the penny stock.
Why do we use these 'rules of thumb' in investing?
Learning from doing, or learning from what others have done, is an important process in investing. But they take time to develop, so investors starting with a $10,000 portfolio might find them out the hard way… unless someone tells them.
Why I wouldn't buy Ardent and Qantas shares with $10,000
For example, I don't like the idea of owning Ardent Leisure, which is the owner of theme parks like Dreamworld and Main Event in the US.
I learnt the hard way that theme parks and leisure facilities require a lot of upfront capital (e.g. to build rides, attractions, bowling lanes, etc.) and the average customer is often not a regular.
That means it spends a lot of money now for what is, at times, an irregular profit. The profit margins are generally pretty thin, too, making it a higher-risk business.
That's not to say that all businesses with high upfront costs and slim profit margins are bad investments. But that's my negative rule of thumb.
Take, Qantas, The Flying Kangaroo. It either leases or buys its aeroplanes, pays staff and a huge fuel bill and engineers before airports clip the ticket for permission to land. Then, it must compete with other airlines and fill up its seats (hopefully not too much – cough United Airlines).
At times, Qantas' business makes great profits. For example, with the recent fall in oil prices, Qantas' profit ballooned — after years of doing relatively nothing. However, if it wasn't for falling oil prices (something it cannot control) it's debatable whether the company would have made such a big profit.
Foolish Takeaway
If I were to pick a few shares to buy in a $10,000 portfolio, Ardent Leisure and Qantas would not be included. At least, not at today's prices.
I would start by buying companies which have produced growing profits over many years and have highly compelling business models.
