10 Things You Should Know Before You Buy a Stock

It may seem like a given that you should do your homework before plunking down your hard-earned cash on a company's stock -- but many people don't, according to a new study.

"There are some investors who simply don't carefully weigh their stock-investment decisions," said Brad Barber, University of California Davis professor and co-author of the recent study All That Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors. "Individuals are heavy buyers of stocks that are in the news -- that is true of good and bad news," he said.

As the stock market crash of 2000 taught us, a carefree investing style doesn't work forever; in fact, its success usually comes to an abrupt end. It would behoove investors to relearn that painful lesson before the next crash. With that in mind, today's column offers 10 questions investors should answer before buying a stock, with some input from Pat Dorsey, Morningstar's director of stock analysis and author of the recent book The Five Rules for Successful Stock Investing.

Some of the questions may see pedestrian to more seasoned investors. If so, humor us a little with our refresher course. And, of course, knowing all the answers doesn't guarantee a winning stock -- in fact, nothing does. But over the long haul, it will make one a better, more well-informed investor.

Question No. 1: What Does the Company Do?

Go ahead and laugh. Then explain to me how JDS Uniphase's(JDSU) source lasers help expand the brave new world of fiber-optic telecommunications. Warren Buffet famously says he doesn't invest in what he doesn't understand; if the greatest investor of the past 50 years is brave enough to acknowledge that he doesn't understand all companies, there must be some wisdom contained within. This first basic question is a simple one, but that doesn't mean it's easy. To answer the question, there are plenty of places to look, including the company's Web site and the fine site that Hoovers maintains.

Question No. 2: Is the Company Profitable?

This is also a simple question, which can be made more complicated by all sorts of variations on a company's earnings. Investors can read the quarterly and annual earnings reports to check out how much net income the company reported, in dollars and in per-share earnings. Tyco(TYC) and the slew of other scandals of the past few years drive home the notion that reported earnings aren't always kosher, but later down in this column we'll address ways to mine for red flags in earnings.