Are you thinking about buying shares? What differentiates good from bad shares? What aspects should you consider before putting your hard-earned money to work? Investing in shares is great fun and can reap fantastic rewards, but there are a couple of things to consider before buying shares. Here are ten of the things you should do before buying shares in any company. If you make sure that you can tick all these boxes will help you avoid any catastrophes and put you on a successful investment path. Just as the saying goes: It is always better to be safe than sorry.
1. Have they paid steady dividends?
Think of it this way: You are the part-owner of the company. Should you not profit from the success of the company as much as the managers and employees? Managers and employees get paid a salary and a bonus for their hard work. In contrast, as an investor you will not get paid a bonus or a salary. As an investor your only two income streams from buying shares in a company are share price gains and the dividends. Whether the share price goes up or down is difficult to predict. Not necessarily in the long-run as you will have picked a great company to buy shares in, a company whose value and that of its shares will enjoy steady gains with time. The short-term story may, however, be different, as your company's shares price will fluctuate with the broader market. A tweet, for instance, can, in this day and age, have a substantial short-term impact on shares. Bad news may negatively affect the share price in the short-term, but a healthy company will bounce back and with it its share price.
Thus, with short-term prices not always being easy to predict, steady dividends are the key to earning good income on a regular basis, regardless of the share price. Secondly, and this is crucial when picky a stock, has the company paid its shareholders dividends even in difficult times or did a temporary market downturn affect their ability to pay their investors? Steady dividends are therefore aspect No. 1 in considering before buying shares in a company.
2. Do the dividends appear too good to be true?
High dividends sound terrific, but sometimes high dividends don't tell the real story. Dividends that appear too good to be true, occassionally are. A company may use high dividend payments to appear more attractive to investors. Take, for instance, a telecommunication provider, that shall remain unnamed here, recently offered dividends exceeding the 7% mark. 7% in guaranteed returns from share investments are certainly attractive.
The issue with their fantastic dividend offer, however, was that rather than pay investors from their profits, the company had to dig into their cash savings. Money that would have been better put towards new investments or the research of innovative products.
If the dividends cannot be paid from profits than why offer such a high yield? For the company in question it was all about attracting new investors and consequentially counteracting the low share price. Usually a high dividend and a low share price is a fantastic investment opportunity. In this case the low share price was justified as the company struggled in general and their management was far from equipped in dealing with any of the business challenges.
If a dividend appears to good to be true, then maybe they simply are. You are better off to pass on such an opportunity and opt for a lower dividend in a company with great future prospects.
3. Are they expensive?
Stock prices are absolutely no indicator whether or not a certain company is expensive. You could look at three companies from the same sector at largely different price points. Is anyone better than the other?
Lloyds Banking Plc
Deutsche Bank AG
Bank of America Corp.
Price in $
Dividend in %
Payout ratio (%)
Is Deutsche Bank better than Lloyds Banking or Barclays, because their share price is higher? Far from it. Rather the opposite. Deutsche Bank has, for years now, suffered from terrible mismanagement and performed badly as a company. On the other hand, Lloyds Banking, the one that appears the cheapest when only looking at the actual share price, has performed better over the last few years. Or are Deutsche Bank only one third as good a company as Bank of America, the leader in our peer group? Again, not by a long shot. Deutsche Bank has an operating margin of merely 3.47 %.
A share price does not tell you anything about the quality of the company. Thus, don’t be misled by it. A Berkshire Hathaway A share might seem expensive at $ 317,000, but is certainly a better buy than many other companies costing a fraction of it.
A high share price does not equal expensive. A low share price does not equal cheap.
4. Have they gone through a hyping phase?
Just as trends in fashion, you will sometimes see certain sectors or companies becoming trendy. Market participants will pour large amounts of money into a certain stock or sector and push up prices. If you go back in history, including very recent history such as tech, you will see these phenomena. Are these companies any better than those from other industries or competitors? Frequently not. These cycles will only make you money if you have joined early in the hyping phase.
Those coming to the party to late are often putting themselves in a vulnerable position and have to endure heavy losses. You may hear the terms Smart Money. A term that describes investments made by investment professionals such as hedge funds, banks, and other financial institutions. Once these mammoths pull the plug and get their money out of hyped stocks, the small investor is left hanging. Thus, make sure that you are not investing your hard-earned cash in a hyped company or sector.
5. Never compare industries
Any ratio, from Price/Earnings to Operating Margin, are ratios that are only useful when comparing companies from the same sector. Comparing the ratios of a hotel chain with a bank will give you little insight into whether or not the share is a good investment opportunity. In case you are not familiar with these terms, I will write a full article on these ratios soon, but for the time being be aware of simply taking one ratio and try to compare it across industries. Just as profit margins differ significantly between products so does the informative value of financial ratios.
The same applies to other factors such as employee turnover or recruitment costs. When looking at a share investment, make sure you compare a company's numbers and story to that of similar companies, not companies from greatly different sectors.
6. Are you in for the growth or the steady payments?
What are you after? Is it dividends or are you betting on the share price going up? Before investing in companies, make sure you know what your general investment strategy is and what purpose this specific investment is supposed to fulfill. If you want to invest in growth stocks, then dividend payments are likely less important to you. In other words, if you want to make money from share price gains, dividend payments may either not be relevant for you at all or take a secondary role for your investment decision.
In the earlier case you may not plan on holding the shares long enough to reap the benefits of dividend payments. In the latter case you may opt to get most of your investment returns from price gains and not regular dividend payments. The choice of investment strategy will guide your decision on whether or not to buy a particular stock.
7. Don’t follow other people's advice
There is absolutely no point following someone else’s advice. Remember the late bitcoin boom? Everyone, from mass media to your taxi driver were eager to get in on the bitcoin boom. Everywhere you went you heard people talking about it being the new big thing. You know I love cryptocurrencies as a concept, but as an investment cryptocurrencies are not even on my radar. I own them because of the opportunities they offer as a parallel addition to the way we currently use money. But investments in my book need to have an intrinsic value and be productive, such as shares, property, or gold that is used in items from computers to jewelery.
When it comes to investing your hard-earned cash, follow your own instincts. You are much better served to trust your gut feeling when making the decision to buy a share in a company or not. Once everyone else has a “great tip” the news is either already out there and you are chasing the crowd (different if they are insiders, but insider trading is illegal anyway) or it is a friend of a friend or they bank advisor who told them about this “superb” investment. Only buy what you are convinced is a good investment. It is your money and your investment after all.
8. Walk with open eyes and trust your gut feeling
If you walk through the world with open eyes, you will come across many great investments. All successful investments I have made came from intrinsic knowledge, the gut feeling as it is generally called. Of course you will still have to do your research, but your brain is the most powerful machine. If you see a sports company’s shoes on every corner in different countries, you feel passionate about a product and remark that those around you are as drawn to a new company, everyone uses the same machine to produce sparkling water, search the internet, or a piece of clothing that has been around since your grandfather’s times and the company still going strong, look into the company. Walk with open eyes, trust your gut feeling, do your research, and if it still feels right, buy a part in the company.
9. Don’t stress yourself
It’s a human shortcoming that we are emotional beings. Just because a company, or the entire market as a whole, is flying from one peak to another, refrain from just throwing your money into the next best thing. Only buy what you really believe in; don’t stress over what others do.
When others panic and you see your investment drop in value, only act if you have been pondering for some time about the adequacy of your investment. Sometimes we need to cut our losses because we made the wrong decision investing in a certain company. Selling or buying just because everyone else is, however, will hardly ever work in your favor. If you are convinced that you have invested in a great company, kick back and enjoy the ride.
10. Look at the company's management
Is the management of the company any good? Has the management recently changed? These are things to look for when investing in a company. The management will decide on the future of the company and consequently your success as an investor. If you agree with their strategies, invest. If their strategy is unclear to you or feels somehow off, look elsewhere to invest your money.