If you are a long-term investor, it never hurts to think twice before plunging into a commitment. My grandfather was a carpenter and he taught me the carpenter’s golden rule:
“Measure twice, cut once.”
As a way of reviewing your analysis of a company, ask yourself the following questions (you can also use these questions to get your analysis started):
Is the Company Really Growing?
Of course, you want to see a growth in earnings and preferably a sustained growth over time. However, keep an eye on revenue growth too.If revenue is not growing or not growing as fast as earnings, find out why. Is the company in a contracting market and milking the last bit of profit with decreasing earnings in the near future?
Increasing revenue and flat or declining earnings can signal several things. The company may be entering a new market or rolling out a new product line and earnings are taking a hit while market share builds.
On the other hand, increasing revenue and declining earnings could signal management inefficiencies or a market that the company can’t compete in on a profitable basis.
The gut-check is to make sure you understand the growth (or non-growth numbers) and what’s behind them.
Do You Understand this Company?
Could you tell someone of average intelligence in a few sentences what this company does and feel comfortable the person would understand?You don’t have to know how to program operating systems to explain that they control how a computer operates by making software and hardware work together. That and little bit more is what you need to know about Microsoft from a technical perspective.
There is nothing wrong with investing in companies with sophisticated business models; however, there are many companies with very simple plans that are outstanding investment candidates.
Don’t make the mistake of thinking that only very complicated business models can succeed in today’s economy. Nothing could be further from the truth.
The gut-check is to make sure you understand what the company does and can explain it in simple terms to someone else.
How Much are You Paying?
After spending some time and effort to thoroughly look over a company, it’s tempting to want to consummate the deal and buy the stock.Before you get out the checkbook, make sure the stock is not trading near an all-time high or riding a hot market.
You have an idea where the stock should be. If it is way off that mark for some reason that has nothing to do with the company, it is probably time to wait for a correction.
Be patient and watch the market for a bad day when everything is down on some economic or sector news. Finding a lower entry point will help you post gains sooner.
What if the stock is much lower than you anticipated? If there is nothing wrong with the company, it may be a good time to buy.
However, you need to face the reality that events may have changed and your analysis is now flawed. Although is may hurt to abandon your research, it is better to walk away from the company than to push ahead and hope things work out.
The gut-check is know what you are paying for the stock and why it makes sense.
