What are the key facts to research before buying shares of a company?

Question

This is a general question so I will create a test case to give it a bit more direction.

Let's consider that I am intersted in buying shares of MadeUpCompany Inc - a tech company that has been around for a while. I don't know much about them apart from what they produce; maybe I like their products which is why I want to invest in them.

Before jumping straight into it, I want to make an informed decision - is my investment likely to make me money based on X criteria?

What are the key things to research about the company and its past performance before buying their stocks?

For example:

• Find out the P/E ratio and how it historically fluctuates when the company releases a new product.
• How stable the stock is (how can I do that?).
• Do they pay out dividends.
• Check if the owners of the company are buying or selling shares in their own company.

Thanks.

Answer 1

I have my "safe" money in index funds but like to dabble in individual stocks. My criteria and thought process are usually like this, let's use SBUX as an example:

1. Understand what the company does. Also paraphrased as "buy what you know". A profitable/growing business doesn't need to be complicated. Open stores. Sell coffee. For SBUX, my decision process literally started inside a store: "Rocky, why are you standing in line to overpay for coffee? Wow, look at all these people! Hmmm. I wonder if this is a good stock to buy?"

2. Check out their fundamentals. Are they profitable? P.E.ratio, book value, and PEG are helpful, and I tend to use them as a gauge for whether I think the stock is overpriced or not. I compare those values to others in the industry. SBUX right now has a PE of ~30, which looks about average for its peers (PEP, KKD, GMCR). So far so good.

3. Does it pay a dividend? This isn't necessarily good or bad, just useful to know. I like dividend-paying stocks, even if it means the stock price might not grow as aggressively. Also, a company that pays a dividend is naturally confident in its ability to turn a profit and generate cash. So it's a safer pick, in my opinion. SBUX pays a dividend, a small one, but that's a plus for me.

4. Am I willing to watch the stock? With my index funds, I buy and forget. With my stocks, I keep an eye on the situation, read the news, and have to make a buy/sell decision regularly. With SBUX, I don't watch all that closely, I just keep up with the news. IMO, it's still a buy based on all the above criteria.

And I feel less silly now standing in line to overpay for coffee.

Answer 2

This is probably my top 5:

1. Company history
2. Current financial situation
3. Future prospects
4. Industry conditions
5. Competitors

Answer 3

I'd say the following are the most important things to consider:

1. Debt. If you see a company with P/E of 5, but debt is 10x its enterprise value, the actual "debtless" P/E is 55 (to be more accurate, you would have to add the interest payments to the earnings to get a better valuation metric). Don't invest! Basically your attitude should be that if you invest, you should be prepared to pay all of the debt away (even though as a minority owner you can't do that). So if a company has $5 shares but $50 debt per share, the true price is actually $55 per share which maybe isn't so cheap anymore. You might also find out if you can find information about the payment schedule of debt. Even if the debt isn't huge, if the payment schedule is way too fast, the company can actually get into trouble.

2. Valuation metrics. P/E, P/B, P/S. Note that very low P/S can indicate risks. For example, the problematic German energy company Uniper had very low P/S. The reason is that it was doing very low-margin trading of Russian gas. Once Russia shut down gas supplies and price of gas skyrocketed, it had to find alternative (more expensive) sources of gas, making a huge loss. So although very high P/S is bad, very low is bad too if it's an indication of very risky low-margin business. If you can, use average earnings over a period of 5-10 years, maybe adjusted for growth, instead of current earnings in your estimates.

3. Growth prospects. If you invest into a film company after it's certain that digital photography will take over, not such a good idea. But don't invest into overvalued growth companies, companies whose value is only based on vague promises of growth.

4. How much you can invest, considering diversification and the true size and importance of the business. My approach is that I always find how much of the product the company makes I use. For example, I have estimated that I need directly and indirectly 13300 kWh of electricity per year. Because of tax reasons, I won't invest more than double of that: so I never own electricity companies making more than 26600 kWh/year of electricity. Similarly, if there's a company whose product I use very little, its weight in my portfolio is small too.

Answer 4

When you buy a company’s shares, you are not only buying the company’s assets and liabilities, but also its reputation as a business.

Before you invest your hard-earned money in a company, be sure to research it thoroughly.

If it is a reputable company, you will find information about its activities easily enough online.

So, when you buy shares, you’ll need to think about a few things:

1. One thing to consider is the company’s financials—what they have earned in the past and what they expect to earn in the future.

2. Another thing to consider is industry research, which can give you an idea of who your competitors are and how your product or service compares against theirs.

3. You might also want to check some news sources before investing, because sometimes outside factors can affect a business.