When you purchase shares, you’re investing in a company. So you want to invest in companies that will give you a good return on your investment without jeopardising the security of your investment capital.
Here are six points to consider when selecting your shares. You’ll notice the points spell I.S.A.D.I.V. (referring to “Is a dividend”) to make it easy for you to recall each one.
Use this checklist to avoid making investment decisions based on hype or fads presented by the media, or popular opinion. There are timeless principles to wise investment, and this checklist embodies the approach used by successful long-term investors.
1. Industry
Look for businesses that are price makers, not price takers.
Resource companies are a classic example of price takers. If the price of a commodity falls in the United States overnight, you can bet the share price of the companies that mine that resource will fall in value tomorrow.
On the other hand, companies such as Woolworths and Coles are price makers. They put pressure on suppliers to reduce their price, which they can do because of their significant buying power.
2. Size of the Company
The security of your capital is critical. Look for shares in companies that have a market capitalisation of more than $1 billion, which essentially covers the ASX200.
Smaller companies may grow faster than their larger competitors in a period of growth. But during an economic downturn the share prices of these smaller companies tend to fall drastically.
3. Assets
Review your target investment company’s balance sheet, which should be readily available on the Internet. Ideally the company will have tangible assets (cash, inventory, investments and term deposits) rather than intangible assets (trademarks, goodwill, patents, etc.).
4. Debt
Debt isn’t always a bad thing. All companies have debt. It helps them purchase assets and grow.
What you should be wary of is the ratio of debt to the company’s assets. Look for companies where the level of debt is less than 50% of its total assets.
5. Investment Return
This is the ratio of the company’s profit divided by its total assets, and you can calculate it by downloading the company’s annual report.
If the company’s profit is less than 8% of its total assets, you should think twice about investing in this company. The company directors’ main role is to grow the company, and the return on investment is a measure of their success.
6. Valuation
There’s one more checkbox you company needs to tick—its fair market price. The company may have ticked all the other boxes, but it may be expensive when compared to its fair market value (i.e. overpriced).
The good news is various research materials are available to help you determine the company’s fair market value.
This checklist is an example of the pragmatic investment approach we teach our clients in guiding their investment decisions. If you’d like more information on selecting and buying shares get in touch with Peter Quinn by submitting an online enquiry or calling us on +61 2 9580 9166 and book an obligation-free appointment.
The information in this document does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it. It is important that your personal circumstances are taken into account before making any financial decision and it is recommended that you seek assistance from your financial adviser.