Ask critical questions before you invest
Before you plunk any hard-earned dollars into a fascinating company you just discovered, you need to do some homework. Below are the kinds of questions you should ask about any potential investment. (Don’t be intimidated or discouraged by the list that follows. You needn’t master everything at once. Beginning investors should just keep learning slowly. We can help you at www.Fool.com, and you can learn a lot from books by experts such as Peter Lynch.)
• What business is the company in? What’s its business model (that is, how exactly does it make its money)? Is it in a profitable, growing industry?
• What’s the company’s track record? Has it regularly rewarded shareholders? Have revenues, earnings and profit margins been increasing in past years? How do these numbers compare with those of competitors?
• What’s discernible from its financial statements? Has the company’s debt level been rising or falling? Are accounts receivable and inventories rising no faster than revenues? Are profit margins healthy and, ideally, growing? How about return on equity (ROE), return on assets (ROA) and other measures? Are there any red flags to worry about and investigate further? Is anything in the statements unusually cryptic? (It’s often best to steer clear of companies you don’t understand very well.)
• What’s the company’s competitive position and strategic vision? Does it have a strong brand? Is it a leader in its field? Is it gaining market share? Do you have confidence in management – and its ability and dedication to keep the company growing, to be straight with shareholders, and to look out for their interests?
• What are the risks that the company and its investors face?
• Is the stock valued attractively? This is a difficult question to answer for any stock, and there’s usually no one right answer, either. You might begin by looking at the company’s current P/E ratio, comparing it to the firm’s historical numbers.
Next week we’ll offer some resources to help you answer these questions.
Ask the Fool
Q: What’s a money market fund? – G.D., Rutland, Vt.
A: It’s a mutual fund that buys goodies such as Treasury bills, short-term commercial debt and certificates of deposit. It sticks to short-term, high-quality investments and is relatively safe. Money market yields vary according to short-term interest rates and typically top rates offered by standard bank accounts. But they fall dramatically short of the stock market’s historical average annual return of 10 percent. They’re great for short-term savings, but ill-suited for long-term investments. Learn more about short-term savings and find good rates for your money at www.Fool.com/savings and www.bankrate.com.
My dumbest investment
Before retirement, we bought a Mexican investment that paid 14 percent interest, as well as land two blocks from the Mexican beach. My wife designed a house to be built when the holdings reached $25,000 in value. Just before that happened, the peso was devalued twice. With the remnants of our investment, we bought a $12,000 house in the mountains and don’t live in Mexico. We should have invested in dollars instead of pesos. – T.K., Santa Rosa, Calif.
The Fool Responds: Ouch. International investing can be tricky. You shouldn’t invest in another nation’s offerings unless you have a good handle on the stability of the country’s government and economy, as well as faith in its financial regulations.