Published : February 23, 2018
Stocks investing is risky, if you do it blindly. Investing itself by no means a simple process. And for stock investing you need countless considerations and have to manage infinite risks. It is an infinite risk because various sources of risk involved when it comes to investment in a stock. Further, risk comes from not knowing what you are doing. This is rightly pointed out by a legendary disciple of Benjamin Graham, Warren Buffet.
So as to reduce risks associated with stocks investing, you must always know the answer to these 10 questions. This you must know before you actually buy a single stock of a listed company. It will help you know where you are investing and ensures that you have done it in a rational style.
Retail investors must thoughtfully weigh their stock-investment choices. He or she must always do their homework before planting their hard-earned money on a stock. Individual investors, mostly rely on news around stocks to make their buy or sell decision. But, it does not work fine in every situation. Stock market runs in a cycle as that of the economy. The boom and burst are the cycles of an economy. Likewise, bull phase and bear phase is there in the stock market.
When an investor tries to ride the wave of news, it usually comes to an abrupt end. Especially in the bear phase of the market. So, to relearn the basics of a stock is a must. Of course, knowing all the basics doesn’t ensure for a winning stock. And nothing can do that. But what these questions will make one a better, more well-informed investor. In the below paragraphs I will describe all the 10 important facts.
When you buy a stock, you did not simply invest your hard earned money. You become the owner of that company. Your amount of shares purchased represent your portion of ownership in the company. And it is counterproductive to own something which you do not understand. Also, all time long-term investor, Warren Buffet never invest in what he doesn’t understand. And we all know that he made his fortune by stocks investing only. So why should we? Only after understanding the companies, we should take heed. The question seems to be simple, but it doesn’t mean it is easy. You need a lot of patience and practice for understanding a business. The first place to look for is the company’s website, whose share you considering to invest in.
An individual investor can’t go inside a company’s headquarters and talk with the management before reaching an investment decision. This, however, never means that there are no ways to find out all about the leadership and the ownership. This too before stocks investing. It is quite possible that different set of people own or promote the business of a company. But at the same time managed by the different group of individuals. Check out the lists the people who manage the business and look out for their professional expertise. Also, ensure that owners have very little say on the functioning of the management. Read and understand how long they have been working with the company and their background. Review the company history as well to ensure the owners say in the company. Research articles about the executives on trade publications from any given industry.
Another simple question, but a little bit tricky to get the answer. Different companies follow different accounting methods which complicate and exhibits variations in earnings. You can read few past quarterly and annual earnings reports. This will help you understand that the company is reporting profit from doing some operation. Or it is showing the profit from other activities such as selling long-term assets etc. Always prefer companies with profit reported from operations. Also, dig out for any unusual source of earning from the past. And perpetually discount it from any regular pattern of profits. This will give you a true picture of earning pattern and sources of profits. Avoid companies with high variations of year-by-year earnings. Check-out per-share earnings as well. Higher the per-share earning, better the pick.
Businesses don’t exist in a isolation. For every Maggi noddles, there are a Ching’s noddles. And a multitude of additional rivals as well. The market share of any business largely depends on their competitor’s strength and weaknesses. Rivals constantly attack to steal business from one another. Tata Motors domestic commercial vehicle business lost its market share to Ashok Leyland in a decade time. Now it is a tough time for Tata Motors to regain its footprint into the domestic market. All this also reflects in both’s share prices as well. So it is always good that you don’t evaluate any investment candidate in isolation.
You must know where the company stands when it comes to market share. Is it a leader in its industry? Or is it new and small but trying to become a niche player? Also, the company may be a bigger player controlling say over more than 10% of the market. Further, you must also pay attention to a foreign competitor. It is always wise to analyze the cost competitiveness of the company under consideration. As low-cost competition put pressure on profit margins.
While analyzing that the company is facing competition from, you should always see for sustainable growth. If you desire that your ownership should be profitable then you need to remain invested for a longer period. And to you remain invested for long period, the company must be in a business of sustainable growth. It is the sustainable growth itself which also helps companies to maintain the competitive edge among peers.
Past provides lots of queues for the future performances. And it is also true in the case of business performances. So it is a good practice to quickly scan old news and past statements before making any investment decision. In case of old companies always look for a company with a history of steady earnings growth. A young growth company may show earnings volatile. But if a mature company shows this, it hints for its difficulty in sustaining strong growth momentum.
If you are seriously attempting to remain invested for long-term, you must display an ability to read the balance sheet. Large business and businesses that are growing need lots of money. And besides equity, debt is their main source of capital. Larger the debt, greater will be the debt servicing cost. Means a large portion of earnings will go exit the company as interest payment with no productive use. However, there is certain management which is so efficient that they grow with little or no debt. Moreover, some have to build cash reserves and surpluses so that they can expand with no external fundings.
There may also be a situation where there is a change in management. And the new management is largely focusing on repayment of the loan. They may not be merely servicing the interest from the profit earnings. As a long-term investor, you must consider these type of companies. The chance to outperform is very high for such companies.
Beside level of debt, interest payments, reserve and surplus, some other thing you must also understand properly. For example, research and development (R&D) spendings and level of inventory also help. If you see an extraordinary investment in R&D this means chances to adopt the changing business environment is high. Likewise, if you see a company with high inventory you should consider it as a poorly managed. A large chunk of profits goes to inventory management.
It’s unusual to spot a firm whose incomes are expanding exponentially. You must consider the value that market pays for such growth and the prospect of future growth. There are several basic methods of determining a company’s valuation. For instance, price to earnings and price to sales are one of them. You can easily find these numbers on companies page of market intelligence. Market intelligence is a database of Indian listed companies. This is promoted by Raghunandan Money. Price-to-earnings is popular by the name P/E multiples. And it is not the perfect gauge, but investors do need to consider it. You should always know how much more you are paying for the stock.
Red-flag means you should look for risk associated with the company and the business. Good companies report the risk factors that are likely to threaten its prospects. Also, they explain the company’s accounting practices and other operating assumptions well. Especially those assumptions that have that have any bearing on the profitability. They also do not hide any factors that may affect company’s growth. Scan all these facts of the company before investing its stock.
Always read some old annual reports along with the current ones. Especially read the management vision for the future of the company. You will get such vision and future outlook in directors speech and management discussion section of annual reports. You must analyze that what the management had planned for the future and how far they have succeeded in it. This will give you a taste of trust on the control. If they did what they have planned, then it is a good news for you. You can rely on this management for your hard earned money. Your share of ownership will not only remain safe but will also grow in such hands.
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