10 Questions to Ask Before You Buy a Stock
No. 4: How Richly Is the Company's Stock Valued?
It's wonderful to find a company whose earnings are growing exponentially. But the other side of the equation is the value the market pays for that growth and the prospect of future growth. There are several basic methods of determining a company's valuation: Price to earnings, price to sales, etc. These numbers can be easily found on Yahoo! and a slew of other Web sites. While price-to-earnings multiples, or P/E multiples, aren't the perfect gauge, investors need to consider how much they are paying for a stock.
No. 5: Who Are the Company's Competitors?
Companies don't operate in a vacuum. For every Coke, there's a Pepsi -- and a host of other competitors as well. The companies are constantly trying to take business from one another. Investors should know where their companies stack up: Does this company have the biggest market share in its industry? Is it a small but growing niche player in a competitive industry? Is it an industry dominated by one company or is it a fragmented industry where even the biggest player controls less than 10% of the market -- such as in the supermarket business? Also, investors should increasingly pay attention to foreign competition, where lower-cost competition can put pressure on profit margins.
No. 6: Who Runs the Company?
Unlike professional money managers, individual investors don't have the ability to drop by a company's headquarters and chat up the management before making an investment decision. However, that doesn't mean there aren't plenty of ways to find out about the leadership. Any company worth its salt will have a Web site that lists the senior managers, how long they have been with the company, their background and the company's history. If the company's executive suite has a rotating door, that may not reflect positively on the company's stability. Beyond the company line on the executive suite, investors should research articles about the executives -- often, trade publications from any given industry are useful in digging into a company.
No. 7: How Clean Is the Company's Balance Sheet?Serious-minded long-term investors need to be able to read over a company's balance sheet. Is the company saddled with a huge amount of debt compared with how much it earns? Checking out a company's earnings alone doesn't tell you if the company has borrowed to the moon to achieve those earnings. It's also useful to see how much the company is spending on research and development, how large its inventory levels are (if they are growing from last year, that may mean business is slowing down). This brings us to question No. 8.
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