10 Questions To Ask Before Investing in a Stock
by Floyd Saunders, Founder of Really Simple Investing
10 Questions to Ask Before You Invest in a Stock🎯
If you are considering investing in individual stocks, because you heard a “good tip” at dinner party, here are the 10 questions to ask before investing in a stock. Researching a company before you buy an ownership position is just fundamentally important so you know what you are buying and the chances this company will continue to be successful going forward.
1. How does this business makes money?
This includes understanding the company's products or services, its target market, and its competitive landscape. You want to find companies that have built what Warrant Buffett calls a “Economic Moat”.
For example, the S&P 500 this year is up 13% YTD, but only seven stocks are seeing most of the gains. The seven stocks that are responsible for most of the gains are Apple, Microsoft, Alphabet (Google), Amazon, Nvidia, Tesla, and Facebook. Each of these companies have built an economic moat around their business making it difficult for other companies to eat into their market share.
2. What is the competitive landscape?
This includes understanding the company's strengths and weaknesses relative to its peers, as well as the potential for future growth. A competitive analysis is a strategy that involves researching major competitors to gain insight into their products, sales, and marketing tactics. Implementing stronger business strategies, warding off competitors, and capturing market share are just a few benefits of conducting a competitive market analysis.
How do you assess a company's competitive advantage? There are a few key factors to look at:
The strength of the company's brand. If customers know and trust a brand, they are more likely to do business with a company rather than your competitors.
Their reputation. If customers have a positive opinion of your company, they are more likely to do business with you.
Their customer base. A company with a large, loyal customer base, makes it more difficult for competitors to steal your customers away.
Their pricing strategy. Lower prices don't always result in an advantage in the marketplace, but it is often a a factor for consumers.
Their product or service offering. If your products or services are better than your competitors, you'll have a competitive advantage.
3. How good is the management team?
This includes assessing the CEO's track record, the experience of the management team, and the company's corporate culture. The primary role of management in a publicly traded company is to create value for shareholders, as reflected in an appreciating stock price.
4. What is the future growth potential?
This includes looking at the company's past growth trends, its new product development pipeline, and the overall economic landscape. A company's growth rate is calculated by dividing the difference between the current period value and the previous period value with the previous period value, expressed as a percentage.
"The investor of today does not profit from yesterday’s growth." -Warren Buffett
The easiest way to come up with a growth rate is to see what analysts are saying. But analysts are often wrong about their estimates for growth, so another way to get evaluate future growth a company is by looking at how fast the company has been able to grow its earnings over the last ten years.
5. How is the financial health?
This includes looking at the company's balance sheet, income statement, and cash flow statements to assess its financial strength. The key to valuing a company's stock to run the various financial ratios. I include a summary of all of the financial ratios you need to know on the Really Simple Investing website.
6. What are the earnings and revenue history?
This includes looking at the company's past earnings and revenue growth to assess its future potential.
7. What is the fair market value?
This includes using financial ratios to compare the company's valuation to its peers and competitors. A value investor for example always wants to buy a stock with a “Margin of Safety” or a discount to fair market value.
8. Is There institutional sponsorship?
This includes looking at how much of the company's stock is held by investors institutional and whether these investors are buying or selling the stock. "Institutional sponsorship" is the mutual funds, banks, pension funds and other large institutions that own a company's stock. These investors have teams of analysts researching thousands of stocks, so it's confirmation to see ownership a stock you're considering.
9. Is there insider trading.
This includes looking at whether the company's CEO or other insiders are buying or selling the company's stock. If you see management purchasing stock, this is usually an indicator of the stock's potential.
"Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.” - Peter Lynch
Insider buying shows management’s confidence in the company and is considered a bullish sign.
10. Reviewing recent news.
This includes looking at recent news articles and social media posts to get a sense of the company's current standing. Yahoo and Google Finance has news articles about companies. Other news sites include: CNBC Breaking Business News, TheStreet, Bloomberg, Barron's, MarketWatch, The Wall Street Journal and Investors Business Daily.
By answering these ten key questions you are increasing your chances of buying quality stocks, with great potential for earnings, growth and dividends paid out to you. These questions help you evaluate investments in more systemic way more by providing a more complete view of a company's financials, management, competitive landscape, and future prospects. When you are making well-researched investment decisions, you are growing you wealth in a serious way.
Floyd Saunders has more than 35 years of experience in the financial services industry. Floyd’s diverse background includes experience in retail banking, investment banking, insurance, investments, annuities, financial planning, and tax preparation. He has authored the following books: Figuring Out Wall Street, Family Financial Freedom and Five Paths To Wealth.
He has been an adjunct faculty member for Baker University, St. Mary’s College, Moraga, California, and Community Colleges in California, teaching courses in personal money management, managerial finance, money and banking, and principles of banking.
He has worked for Bank of America, JP Morgan and JPMorgan Chase, TransAmerica, Wells Fargo, Citibank, WoltersKluwer/CCH, H.R. Block and as a consultant in the financial services industry. He has prior experience as a registered representative and has published several articles on personal financial planning, investing and personal money management. Learn more at floydsaunders.com