Buy the company not the stock

When buying stocks, we must remember we are buying companies.  Here are 6 important points to remember when researching a company for an investment opportunity

1. Does the company have potential to make money in the future?
Remember all stocks are traded on the outlook of the future.  That is why a company can come out with a great earnings statement and make a trillion dollars, but still has a falling stock price. This is because the price is not about how good they have done in the past, but how good they may do in the future.

2. Price does matter.
What determines if a stock is “expensive” is not the price of the stock, but how the price of the stock is compared to the amount of money they make.

This is why, when you buy a stock, we must learn terms like

• P.E.  (price to earnings) – When companies go public they basically break themselves up into little pieces (stocks).  PE is how much money they earn per year divided by the current price of one share.
• P.E.G. (price of earnings /  growth) – This basically takes their P.E. amount and divides it by the companies expectant growth rate (earning more money each year).
• Yield (amount of dividend / by earnings) –  Some companies pay a part of their profits back to shareholders.  This is called a dividend and the yield is the amount they pay (as a percentage of earnings).

Now there are many other metrics used to decide the value of a stock (download our Stock Market Definitions Tool for further explanation).  Just remember that a company needs to be making money, as well as have the ability to keep making money.

3. How well does the company manage its income, cash flow, debt and its ability to do better than its competitors?
Basically this means that if a company keeps spending more money than they make, uses more money to make things than sell them, has high debt and little cash, loses more money than it makes over the years, and always seems to be a step behind their competitors than it’s probably not a good company to buy.

Remember just because a company sounds good doesn’t mean it’s a good stock to buy.

4.  How good is the management?
This is very important in that even a good management team can perform well in a bad market or industry. Yet a poorly run company with a bad management team can bring down even what once was an exceptional company.

So look out for constant revisions of earnings, signs of investigations or lawsuits, many product recalls, missed estimates, heavy debt loads, poor product image, and other signs that management is not doing their job.

5. Try to buy what you know.
It’s easier to research and understand a company you are familiar with for investment opportunity. You are more likely to be confident in buying their stock than in something you know little about.  Also try to tune out all the constant drum beat from the news, experts and stock analysts.

Remember many have an invested interest in whether the stock goes up and down, and very little interest in whether you make or lose money.  So try to stay within the areas you are comfortable with, and if you want to expand your horizons, make sure you do your homework first.

6. Try to stay diversified.
Yes you can make lots of money doing or buying just one thing.  However once you have made money,it’s usually safer to spread you money out in various areas.  Like they say do not put all your eggs in one basket.

Even if it’s a big basket. So try to buy stocks in different industries, stocks that pay dividends, trade in different markets even internationally and look at buying some index, electronically traded funds, bonds, precious metals, and mutual funds.

Remember when you buy a stock, you are buying the company.  Owning stocks has been a proven method to increase your wealth, just do your research first.

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