Know the company before buying its stock

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Investing is one of the ways in which you can make your money work for you. The idea is to invest so that you can get returns in form of capital gains or dividends. However, not all investments can yield positive returns. Due to the high risk nature of investing in the stock market, you have to know the company before buying its stock.

Furthermore, there is a significant difference between an investor and a gambler. Remember an investor’s goal is to own an asset that generates income. Therefore an investor needs to target an asset that is of great value to the customers in the long term. The investment should not be fueled by speculation but by the current and future potential of the asset.

WHO and WHY before WHAT

This is the most important stage that should never be skipped. Before you buy any investment or partake in the stock market, you must know WHO you are.

WHO

The WHO questions are those directly defining the person you are. People are different and therefore what works for one person may fail on the other.

Let us list some of the things that define your WHO below:

• Risk appetite
• Age
• Marital status
• Number of dependencies
• Source of income
• Size of income
• etc

WHY

After knowing who you are, you need to know WHY you are planning to invest. Remember that each investment vehicle is more suitable for a specific goal.

If your goal is to buy something in the short term, then your best option may be saving money in a less risk asset like a bank saving account or a money market.

However, for long term goals like early retirement, kids’ university fees or financial freedom, you can choose an investment vehicle with high risk and a potential for high returns. The stock market can be used for these kind of goals.

Know the company before investing

After addressing the WHO and WHY questions, you now have a clear understanding of yourself and this makes it easier to know what you want.

Now suppose you are convinced that the stock market is the best for you, then you may need to decide whether to go for individual stocks or Exchange Traded Funds (ETFs). If your preference is individual stocks, then you need to know a company before buying its stock.

Important articles:

• First time investing – how and what to invest in
• Buying and selling stocks

There are many ways of evaluating the potential of a company. We will focus on some of the most important factors an investor needs to consider. The order is not important and depending on the WHO and WHY questions above, an investor should be able to evaluate the most important factors that addresses his/her preferences.

1. The type of product or service the company produces

It is very important to know the source of the company’s revenue. This is what drives the profits of the company.

Know the demand of the company’s products or services. Remember a company may have been profitable in the past but if the demand of its products or services is dying then future profits may drop.

You have to evaluate the expected future demand of the products and services of that company. If the demand will remain constant or increase then there is a higher chance that the company will be profitable in the future.

2. Historical performances

History is not the best indicator of the future but it can show you a lot about the company. You can check how the company performed in the past by analyzing the:

• price trends,
• volatility of the stock price,
• historical dividend yields,
• dividend growth and payout ratios,
• profitability ratios like Earnings per Share (EPS),
• Price Earning (PE) ratio,
• debt to equity ratios,
• e.t.c

The list of what you can analyze about the past performance is very big. We urge you to go through the financial statements to get the full understanding of the income and the balance sheet of the company.

This information can be obtained from the likes of Yahoo Finance.

3. How does the company finance its operations?

Remember that in case of a company filing for bankruptcy, the lenders will get their share of assets first from the company and there may be nothing left for equity holders.

Depending on the type of industry, a company with low debt is favorable. You can get this information from the Balance sheet of the company.

Another less popular opinion is about the proportion of institutions and insider investors in the company. It clearly shows a great level of belief in the company if the executives of the company have big exposures on the company. At least the interests of the shareholders will be represented by the company executives.

4. What are the growth prospects of the company?

For investors who are looking to gain from the growth of the company, it is very important to evaluate the likelihood of the company expanding and increasing its earnings.

Note that companies in the growth phase are likely to plough back profits, so low dividend yields are expected.

5. Management or leadership of the company

How good is the management? Can the management be trusted enough to make the company profitable?

A good management should be able to balance between taking care of the company’s employees and customers as well as its shareholders.

6. How loyal are the company’s customers?

Loyalty is important if the company wants to keep the demand of products or services high.

If the competition is high and without loyal customers, it is easy to lose money through leaving customers.

7. How easily can the company adapt?

The ability to adapt is very crucial especially in an industry with high innovation like the Technology industry.

A highly innovative company has an ability to offer new solutions to problems. This makes it easy to adapt to a change in demand patterns.

Conclusion

There are several factors an investor needs to consider before buying the stock of a company. The future returns from investing in a company depends on the potential of the company. Therefore, you need to know the company before buying its stock.