Here are 9 questions to ask before buying a stock.
- What is good about this company?
- What are the risks associated with this company?
- What is the likelihood of each risk coming true? If so, what are the consequences of it?
- What is the company doing to mitigate these risks?
- What does the future of the company look like?
- Does the management possess integrity, honesty and intelligence?
- What is the intrinsic value of this company?
- How much of a discount is the company currently selling for?
- How do I know I am correct in my assessment? What evidence do I have to backup my answers?
The answers to questions 1 through 6 can be found in the annual reports. You should probably read annual reports of the past 3 to 5 years to get a clearer picture of the company. It will tell you a lot about the future of the company, risks associated, and management’s ability.
Answers to questions 7 and 8 will require you to do some math. There is no one way to calculate a company’s intrinsic value. Googling “How to calculate a company’s intrinsic value” will give you plenty of ideas. Research a few, and use multiple methods to see if the answer is within the same ballpark.
In my experience there are three reasons people will lose money in the stock market.
- Lack of extensive research
- Gut feeling so strong investor loses any objectivity
- Arrogance – It is correct because I say so.
While questions 1-8 are about extensive research, question 9 is about eliminating arrogance and gut feelings you have about a stock. It’s about ensuring you have actual evidence to backup your gut feelings, and make an informed decision.
Hope this helps.
Every time I’ve been strict about following these requirements, I’ve made money. It’s true 100% of the times.
Other times, I’ve lost money.
Apply these requirements to your investment selection process, and see how it works for you.
Also, I apologize for the ruthlessness of the following sentences. These are absolute necessities for my investing methodology. Any leeway is these matters is inconceivable.
I require my investment to either produce a product, or deliver a service.
When a business produces a product, or delivers a service, the value of the business is no longer hypothetical. It relies on the quality of the product or service delivered. This requirement automatically eliminates all commodities and cryptocurrencies from my radar.
I require the business to be profitable before I invest in it.
Companies that continue losing money for more than 5 years after inception in the name of growth, do not interest me. The senior management in such businesses is made up of incompetent folks.
I require the business to be self-sustainable.
The business has to operate on little to no debt. Businesses that heavily rely on debt for its operations do not deserve a place in my portfolio. As soon as the river of debt dries up, the operations take a nosedive in such businesses.
I require businesses to have increasing revenues and higher profit margins.
Combination of these two factors fortify a business. It gives it a moat. Longer the sustainability of this moat, better the business.
I require the business to be on extreme sale before I invest in it.
When a high-quality business is being offered at a significant discount compared to its intrinsic value, the odds of losing money are almost non-existent, and odds of making money are greatly in my favor.
On a regular basis, I go through all my files, clippings, etc. Most things I save “in the moment” turn out to be useless shortly thereafter. So, those get chucked.
One of the interesting things I found saved from earlier was a list of bear market indicators from Bank of America. Sharing them here with you.
- Federal Reserve raising interest rates
- Tightening credit conditions
- Minimum returns in the last 12 months of a bull market have been 11%
- Minimum returns in the last 24 months of a bull market have been 30%
- Low quality stocks outperform high quality stocks (over 6 months)
- Momentum stocks outperforming (over 6 to 12 months)
- Growth stocks outperforming (over 6 to 12 months)
- 5% pullback in stocks over the last year
- Stocks with low price-to-earnings ratio underperform
- Conference Board’s consumer confidence level has not hit 100 within 24 months
- Conference Board’s percentage expecting stocks go higher
- Lack of reward for earnings beat
- Sell side indicator, a contrarian measure of sell side equity optimism
- Bank of America Fund Manager Survey shows high levels of cash
- Inverted yield curve
- Change in long-term growth expectations
- Rule of 20, trailing price-to-earnings ratio added to CPI is above 20
- Volatility index spikes over 20 at some point within the last 3 months
- Earnings estimate revisions rule
I found many of these to be interesting, and useful.