Many things have been said regarding the important things to look for in an investment before committing your hard-earned dollars. Although in certain cases, the relative importance of these things may vary from investment to investment, they are still nonetheless important. To help you facilitate your decision-making process when investing, here’s four major things you have to think about before you commit to any stock idea you might have. #1 – Total worth of the company Investing in any company requires looking into more than a stock’s market price. The cost of obtaining the whole company should be analyzed and…
Many things have been said regarding the important things to look for in an investment before committing your hard-earned dollars.
Although in certain cases, the relative importance of these things may vary from investment to investment, they are still nonetheless important.
To help you facilitate your decision-making process when investing, here’s four major things you have to think about before you commit to any stock idea you might have.
#1 – Total worth of the company
Investing in any company requires looking into more than a stock’s market price. The cost of obtaining the whole company should be analyzed and this particular cost is termed as a share’s market capitalization; if a company has about one million outstanding shares and a share price of $50 each, the market capitalization of the company is $50 million.
The importance of assessing a company’s market capitalization allows you to estimate the amount of risk involved in order to match your own level of risk tolerance. For instance, historical data has shown that small cap stocks are much more volatile than large cap stocks, where the latter’s usually known as “blue chips”. An example of a large cap stock would be telecommunications operator SingTel (SGX: Z74) with a market capitalization of some S$56.9 billion. Meanwhile, a small cap stock could be a company like XMH Holdings (SGX: M9F), which has a market capitalization of only S$136 million.
#2 – Why you are investing in a particular company
It is paramount that you answer this question before you start putting your hard-earned money into any investment. One should never choose a company based on fondness or hearsay but rather, focus on its business fundamentals.
A few questions you can ask yourself include:
1. Is the management team doing a good job by rewarding shareholders through solid operational performance and efficient use of capital? Examples of an efficient use of capital include buying back shares opportunistically when prices are low or making value-accretive acquisitions.
2. Are insiders of the company, such as its directors and top-level management team, buying the company’s shares enthusiastically?
3. Has the historical financial performance of the company been up to par and has earnings per share increased steadily? This ties into the first question regarding management’s operational capabilities.
4. Do you understand what the business is about? A good way to gain quick understanding of businesses is to focus on industries related to your day-job. Say you are a nurse by profession, you could look towards healthcare-related companies instead of venturing into oil and gas companies as an example.
#3 – How long are you willing to invest for?
Year after year, professional money managers attempt to beat the market and many have failed (and would fail) in doing so. And, one of the major reasons for their poor performance is an over-confidence in their abilities to time the markets. Timing the market requires an investor to be nimbly buying only at troughs and selling at the peaks. Unfortunately, such a strategy has turned against many a money manager and layman investor as well.
In contrast, investing for the long haul gives investors much better odds of success. Like what billionaire investor Warren Buffett says, “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years”. By investing in fundamentally sound companies over the long run, you can reinvest a company’s dividends and let compounding work its magic.
While there are many other examples of long-term winners in our stock market, inspection and testing outfit Vicom (SGX: V01) is certainly one that has rewarded long-term investors. After accounting for reinvested dividends, shares of Vicom have gained 1,072% over the past 10 years to its current price of S$5.90 and a big part of that has been the company’s steadily growing dividend.
#4 – Margin of safety
Lastly, there will be times when companies with solid fundamentals are noticed and have their share prices pushed up to the brink by the market. In this case, you should remember to always be ready to walk away from any investment that proves to be over-valued as there has to be a focus on the margin of safety when evaluating an investment. Over-valuation can really kill an investment. With Buffett’s penchant for pithy nuggets of wisdom, he gets the last word here, “Price is what you pay, Value is what you get”.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.