9 Simple Steps to Perfect Investing
Every Investor Will Benefit From Proper Due Diligence
These nine simple steps will make all the difference in your investment results. This is how to turn your research into profit.
Investigate an investment to your satisfaction before you buy, so you understand exactly what you are purchasing. The sad truth is that most people do little or no research, and most of their trading decisions are based on just about anything except proper analysis. They don't realize a tiny amount of due diligence will help them get it right every time.
1. Barriers to Entry
The more difficult it is for a new business to operate in a space, the higher the barriers to entry. For those companies already "in the door," higher barriers are great because they keep new competitors away. This point is especially true for penny stocks, and new or tiny companies, because if they do not own a disruptive technology or important patent, they are held out of the market.
For example, the barriers to starting an online t-shirt business are very low, while selling precision military ordinance are very high. Robots for brain surgery? High barriers to entry. A new kind of shoelace? Very low.
There are all kinds of barriers to entry, depending on the industry. In some cases organizational approvals are required (Food and Drug Administration, Congress, etc.), while in others the very complexity of the product makes new competition unlikely (satellites, electric cars, etc.).
2. Competitive Strengths
Some may refer to this as a Unique Selling Proposition (USP), but that does not go far enough. Any number of factors can give a business an advantage over their competitors. Their patents, management team, even their geographical location may be significant.
For example, a manufacturing business can produce products for far less money in China than Manhattan.
A technology company will have a much larger pool of potential employees in Silicon Valley than in Mexico.
Identify as many strengths (and weaknesses) as you can for any potential investment. For extra points, take a look into their competitors as well!
3. Market Size and Share
Understand the company's market, and specifically the total potential size of that space. Do they develop treatments for the multi-billion dollar cancer industry, or will the business be trying to own all sales of only "green markers used for lemonade stand signs?"
There are three quick steps to establish the size of a market, and the quality of the investments involved:
- Understand how potentially huge (or tiny) the total market might be — if one company got every possible dollar in revenue from the space, how much would that represent in total sales?
- Determine what percentage of the market is currently owned by the company. This can be done by various means; calling the company directly (see point 9); reading online articles about the industry and the business for clues; trusting comments on the company's website and within their press releases; calculating for yourself using sales data divided by total market size.
- Establish if their market share is growing or is expected to grow. You may have to watch the company for a while (months or years) to establish an ongoing trend.
Any company operating in an industry which is growing in total size, and which is gaining greater amounts of market share over time, will typically be an excellent investment.
4. Try the Product or Service
This is the fun one! You like the business which sells that new bike, or coffee, or television? Try their product out. Alternatively, speak with someone else who has, or several people.
In addition, the most helpful comments will come from what their competitors are saying about the product. You can call the competition directly, or look online for reviews, comparisons, and ratings.
5. Stock Market
There are higher-quality stock exchanges than others.
Lower-quality companies tend to trade as Pink Sheets, OTCQX, and OTC shares. The better businesses will typically trade on the exchanges which have higher listing regulations, pricing, and requirements.
If the investment in which you are interested is on one of the low-end, back-alley marketplaces, you may want to reconsider the choice.
6. Trading Structure
Just glance at the trading chart — are shares in a five-year downward slide, or have they been climbing to new heights in the last few months? The story you've been told about a company can be altered dramatically with one look at how the shares have been performing.
7. Branding and Positioning
Every product and service has a brand. These are thoughts customers and potential customers have in their head. These beliefs often create sales, encourage people to pay more, or even build multiple-purchase loyalty.
Take McDonald's for example: Most people do not think of their food as healthy, but will agree that the restaurants are convenient. When you take a Disney cruise, you probably have an idea about the caliber of experience to expect, before you even set foot on the boat. This is all because of branding, beliefs in your mind from personal experiences, comments from others, or observations.
Positioning relates to the space a brand holds in your head. Perhaps you think of Volvo when you think of safety, but you consider Lamborghini's to be the fastest vehicle. Whether or not any of this is accurate does not matter, but the fact that you believe it to be true does matter, because it may influence your purchasing decisions.
Look for strong branding and positioning in any potential investments. When these aspects of the business are strong, the underlying investment will benefit dramatically in many ways, including, but not limited to, sales.
8. Financial Situation
When you buy a share of a stock, you are buying a share of the underlying company. When that business grows, the shares will typically increase in value.
Take a look at the business in terms of the Income Statement (how much they are making/losing, their expenses, and their sources of income). Even more important will be the Balance Sheet (how much they own, compared to how much they owe — assets versus liabilities).
Look for trends of improvement from one financial report (every three months) to the next. When sales increase over time, or liabilities shrink, or earnings rise, it could bode very well for the shares.
9. Call the Company
This point is last, because most people never do it, even though they absolutely should. Every publicly traded company (on any legitimate exchange) is legally obliged to have an investor relations contact, who will speak with current and prospective shareholders to answer any questions.
"He who asks is a fool for a minute, he who doesn't ask is a fool for life." — Chinese Proverb
You may be amazed at how much a quick discussion enlightens you about the underlying company. Ask some simple questions (listed below), and look for warning signs, such as a busy signal, or no one answers the phone or ever calls back.
Some easy questions to get you started:
- How many employees does the company currently have? How does that compare to two years ago? Do you expect the headcount to increase in the next few years?
- How big is the total market for the technology/solution/product? What percentage of that market is owned by your company, and has it been rising or falling?
- Will the company need to raise more money, or will current operations be enough to sustain the business?
By following these simple steps, you will have a much greater amount of clarity about the investment. In fact, you may multiply your trading results! Like all things in life, a small amount of work will go a long way, and make the big difference between the "winners" and the "whiners!"