The best new stocks to buy will avoid these risky strategies and instead offer investors sound fundamental value

When looking for new stocks to buy, many investors focus on today’s fastest-growing companies and industries.

Some recent startups have enjoyed explosive growth because they were able to harness modern computer and communications technology to quickly enter and move toward dominating existing industries, such as taxi services, hotels and popular music.

However, there are some risks that Successful Investors should watch out for with these stocks:

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The best new stocks to buy are not focused on growing by acquisition

A growth by acquisition strategy is inherently risky. It’s a little like buying new stock issues or IPOs. (See more below.)

These acquisitions generally come on the market when it’s a good time to sell. That may not be, and often isn’t, a good time to buy. Insiders and managers at the selling company know a lot more than the buyers about the company and its business strengths and weaknesses.

Some takeovers work out well for the buyers, of course. This doesn’t diminish the inherent risk. More important, risk multiplies as takeovers become a habit.

Takeovers are more likely to succeed when the buyer is already a successful company and is under no pressure to buy anything. That way, the buyer can take its time and wait for a truly attractive, low-risk opportunity to come along.

Successful, well-managed companies can succeed with growth by acquisitions. But they use acquisitions as a tool for pursuing a core business. They do not make acquisitions the core of their business.

Even for those well-managed major companies, a growth-by-acquisition strategy isn’t foolproof, and some of them stumble, and fail. However, if a takeover starts to falter, well-managed companies are likely to cut their losses while there is still some value to salvage.

That’s one more reason why, in our Successful Investor publications and portfolio management service, we focus on high-quality, well-established companies. They make fewer takeover blunders. And as mentioned, when they do make mistakes, they tend to recognize them earlier, and cut their losses before they reach catastrophic levels.

New stocks to buy usually don’t include IPOs

Our rule on new stock issues, or Initial Public Offerings (IPOs), is simple. We generally stay out of them.

Underwriting brokerage firms try to spark publicity about the new issue, and they pay extra commissions (as much as double the regular rates) to spur their salespeople to sell the new issue to their clients. This tends to create a high-water mark in the price of the new issue. Unless the new company can follow up with business success, the price of the new issue may languish for months or years. It may drop.

Some new stock issues—so-called “hot new issues”—depart from this pattern. They begin moving up as soon as they hit the market. Some even “gap upward” on their first day of trading. That means their first public trading takes place well above the new issue price.

This possibility attracts buyers who fail to appreciate how rare it is. In addition, the underwriting brokers can generally tell when this is going to happen, by judging the reaction of their biggest clients (who of course get first pick on their new issues) and the media.

However, they reserve most of their allotments of hot new issues for their biggest and best clients. New clients may get to buy only token amounts of a hot new issue, if any.

Speaking very generally, your best course of action as an investor is to stay out of most new issues. You’re better off to wait until they have been trading for a few years and have shown some of the potential that the initial hype promised.

Look for investment quality when considering new stocks to buy

There’s no easy answer to a buy-now-or-wait dilemma. At times it may pay to hold off—for instance, a company’s stock will often rise when it announces a stock split, then fall after the split takes effect.

In the end, our stock trading advice is that if a stock is truly worth investing in, you should be willing to buy it at current prices, even if that means you run the risk of having to sit through a 5% to 10% setback. After all, before it suffers that next 5% to 10% setback, it may first go up 50% to 100%.

Above all, you can limit your risk with stock investments by sticking with our three-part Successful Investor philosophy:

1. Invest mainly in well-established companies with a history of sales and earnings, if not dividends;
2. Spread your money out across most if not all of the five main economic sectors—Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities;
3. Downplay or avoid stocks in the broker/media limelight.

When you look for new stocks, what is your strategy in staying away from potentially risky investments?