Fifteen points to check before buying a stock

Buying a stock is not as simpler as it seems. Usually financial community buys a stock which is recommended by some expert or broker or any friend. But it should be not like that. Before buying any stock you have to make sure that the company you are buying is having greater opportunities ahead. How to measure that?

There are fifteen points that measures strength of a company. So as an investor, you must consider these fifteen points before making any investment.

1.) Company should have sufficient market potential so that it can increase its sales for at least several years

No company can survive in a market with stationary or declining sales curve. It must have increasing sales curve for a specific time period.It is very challenging for an investor to correctly judge a long range sales curve of a company.Superficial judgment can lead to wrong conclusions.If a company making one time outstanding profit then it’s not considered. Sales must be analyzed for a specific time horizon.

2.) Company should have the determination to continue to develop products that will increase sales even when the growth potential of currently attractive product lines has been exploited

Any company to enhance its sales and growth, improve old products and develop new ones. It is up to manager that how efficiently its research team is working on innovative products to sustain for long in a market. Hence it is all about management attitude.

Company may have several divisions in it. Usually the company having research process around each of its divisions is more successful than working on a number of unrelated new products.

3.  Company should effective in research and development efforts in relation to its size.

In previous point we understood that developing new products is vital for improving sales growth. That is why research and development factor of any company is also considered important. How much a company it utilizing its sales for research and development is measured by diving research figure by total sales. To analyze this factor, an investor compares this figure with the company of same filed.

4. Company should have above average sale organization

First benchmark of success for any company is the making of repeat sales to satisfied customers. Usually investors consider parameters such as production, research, finance to evaluate company’s performance.In spite of having so much importance, Sales of company gains less attention of investors.

Any company’s success is based on three parameters. Production, Sales and Research. Saying that one is more important than another is like saying that the heart, the lungs or the digestive tract is the most important single organ for human body. The company which steadily improving its sale arm usually achieves more success. One time profit can be achieved by manufacturing or research skill, but for steady long term growth sales is vital.

5Company should have worthwhile profit margin

In point 4 we have understood how sales of a company plays major role in success of a company. Sales growth makes company successful only when it coverts in profit. To examining company’s profit investor should study its profit margin. Profit margin is net profit divided by it sales.

In good time a marginal company whose profit margin is lower increase profit than a company having higher margin. This happens only when weaker companies doing good business than stronger company of the same field. These earning will decline when business tide turns. Long term investment profits are never achieved by investing in marginal companies. Only exceptional case when you can consider marginal companies for long range investment when strong indication of fundamental changes in a company.

6. Evaluate what the company is doing to maintain or improve profit margins

The success of a stock purchase does not depends on what is generally known about a company at the time of purchase is made. Rather it depends what gets to be known about it after the stock has been bought. Therefore the profit margin of past is not important but future profit margins are important.

There are two ways of doing this. First is by simply raising prices. If a company contains a products having strong demand in market this method  is possible. But this method is temporary, because competitive production capacity is created and which outbalance the increased gain. Profit margin start to shrink.

Second method is cutting costs and improving profit margin. In some companies it is achieved by designing new products that will reduce cost. Investors can easily access this parameter as this is the field about which most top executives talk in some detail.

7. Company should have outstanding labor and personal relations

If worker feel they are fairly treated by their employee then productivity per worker will automatically increase. If an enterprise is better managed and having less labor turnover, then some unnecessary expenses can be avoided. The company that settles grievances quickly usually has good labor relations. If a company having constant strikes which is not sign of good labor relation.

Reverse is not true here. No strike company doesn’t always have good labor relations.  Sometimes the absence of conflict not means happy relation but fear of conflict.

Two parameters are considered to measure labor relation of company.

  1. Relative labor turnover ratio in one company as against another in same field.
  2. Relative size of waiting list of job applicants wanting to work for one company as against others in the same locality.

8. Company should have outstanding executive relations

As we discussed in previous point that good labor relations are necessary for success of a company. Same way good executive climate is necessary for success of a company. Lowest levels should have respect and confidence in board chairman. They should have feeling that promotions are based on ability not factionalism.

Management should not tolerate who doesn’t cooperate in team play, so that friction can be reduced.

9. Company should have depth to its management

All human are finite, so even for smaller companies the investor should have some idea of what can be done to prevent corporate disaster if the key man no longer available.

The company continues to grow is necessary. Management depth is required for that because sooner or later a company will reach a size where it will not be able to take advantage of further opportunities if it does not starts developing executive talent in some depth.

This is achieved by delegation of authority. It means from very top on down, each level of executives should be given real authority to carry out assigned duties in effective manner.

The second point comes here how top manager welcome and evaluate suggestions from personal. If top management is having pride not to consider anyone’s suggestions of improvement then it is not good sign.

10. Evaluate companies’ cost analysis methods

Company should manage cost analysis efficiently for success. It has to show cost of each small step in its operation. Company may handle several products. In that case management should aware of cost of particular product in relation to other products so that they can estimate what needs more attention.

11.  Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

12. Evaluate whether the company has a long-range or short-range outlook in regard to profits

Some companies manage affairs so that they can gain maximum profit right now. In contrast,  other companies curtail maximum immediate profits to build goodwill and thereby gain good amount of profits over a period of the years. The way company deal with customers can be noticeable. The company that will go to special trouble and expense to take care of the needs of regular customer caught in unexpected jam may show lower profits on the particular transaction, but far greater profits over the years.

The investors should consider companies having long range outlook profits.

13. Evaluate if the company for its growth require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this growth.

Intelligent investor should not but stocks because they are cheap but only if they give promise of major gain to him.

If a company needed more cash once top debt limit is reached, it could still raise equity money at some price as investors are eager to participate in ventures like this. If the borrowing power is not sufficient then equity financing becomes necessary. In this case how much the attractiveness of investment depends on calculations as to how much the dilution resulting from the greater number of shares to be outstanding will cut into the benefits to the present stockholders.

If equity financing will be recurring within several years of the time of stock purchase and if this equity financing delivers only a small increase in per share earning then the company must have poor financial judgment to make stock worthwhile for investment.

14.  How the company talks to investors about its affairs when things are going well but clams up when troubles and disappointments occurs.

15. Does the company have a management have a management of unquestionable integrity?


Source: Common Stocks, Uncommon Profits


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