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Three Important Questions to Ask Before Making an Investment

Let’s say you’ve found a company that has been growing steadily over the past few years, has a strong balance sheet, and carries a reasonable valuation. That sounds like a great investing opportunity, doesn’t it?

But before you click that buy button or call your broker, there are important questions you have to ask yourself before you make that commitment. Here are three of them:

1. Where is the company at in its business cycle?

Many companies operate in a cyclical business environment. It is important to know roughly where the company is at in the cycle.

For instance, a cyclical company might be trading at a very “cheap” valuation in terms of its Price/Earnings ratio just before it reaches the peak of its business cycle; investors who are caught unaware by the subsequent and inevitable downturn might then have to stomach painful losses. Thus, knowing the industry itself, and whether or not it’s cyclical,  can help to prevent us from making such a mistake.

As  a real-life example, many shipbuilders and shipping companies such as Yangzijiang Shipbuilding Holdings (SGX: BS6) and Neptune Orient Lines (SGX: N03) were making significant or record profits just before the downturn of the shipping industry.

2. What is the attitude of the government and society toward the company?

Companies need to be on good terms with both society at large and the government in order to have a sustainable operating environment. For example, after the global financial crisis, many foreign banks started to face tougher regulations and higher compliance costs. This in turn caused them to have to trim their businesses and focus only on their core markets.

These turn of events have been quite prominent in Asia with many Western banks having to sell out their Asian business in order to focus on their home markets. This created an opportunity for Asian banks to expand their banking businesses in areas previously dominated by foreign banks. For instance, the three banking giants in Singapore, DBS Group Holdings (SGX: D05), Oversea-Chinese Banking Corporation (SGX: O39) and United Overseas Bank (SGX: U11), have been aggressively expanding into the private wealth and investment banking space after the global financial crisis.

3. Are there eminent threats from disruptive innovations?

Lastly, for any company we are planning to invest in, we should be looking out for the threat of new disruptive inventions that are making their way into the mainstream market.

One big theme in our current generation is the rise of online retail, which has created more intense competition for tenants in traditional brick-and-mortar retail malls. These sequence of events would of course have possible ramifications for real estate investment trusts that predominantly own retail malls, such as Frasers Centrepoint Trust (SGX:  J69U) and SPH REIT (SGX: SK6U).

Foolish Summary

The analysis conducted for any investment should be a dynamic process and deeper research into a company’s industry and the ecosystem it is in can sometimes provide a better picture on the prospects the company actually has.

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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 Stanley Lim doesn’t own shares in any companies mentioned.