Before You Buy

Ok, so you followed the instructions in the About Section, and you found a stock or two that seem promising. What to do next: do you run to a broker and hand over your hard-earned cash?


Assessing your Stock

You probably want to dig a bit deeper to find out who you are getting into bed with.

There are quite a few things that you can look into to find out more about your potential investment. And remember, if they are selling cheap it must be for a reason so its good if you find out the reason by doing a little detective work first.

Key Factors to consider

While you dig a little deeper feel welcome to enter this information in the "Key Factors" section for each company.


Negative Press

Check online news for any negative stories that have affected the stock in the last year. Be aware and understand how these impact value and profitability. While the news may be bad there is still room for making money if the market overestimates the impact of the news.


Ongoing litigation

Check for any pending court cases involving the company. Try to measure what impact a pay-off will have on the value of the company and note the erosion to profits from keeping up the legal battle.


Hidden Value and Unique Resources

Look for hidden value in unmeasured assets (value of land or telecoms license for example), try to find potential for long term profits in unique resources the company holds such as mines, patents, or barries-to-market such as distribution networks. These can keep the company making above-market profits for a longer periods of time since they will face less competition.


Labour Unions

Employees may strike and ask for more pay. While this is great for them you need to be aware of the negative impact of labour unions on profitability. If the company holds a pension on behalf of their employees you need to understand what sort of burden this creates on value and profitability.


Technical Obsolescence

Unfortunately markets change and some companies get left behind. Is this stock one of those companies? Are they still selling horse-drawn carriages in the era of automobiles? Be aware of how this impacts the company. It helps to read through their annual reports and see what plans the directors are making to turn things around.


Director Dealings

Try to find if any of the company management team have purchased stock recently. Apart from creating a strong signal out in the market that the stock is being undervalued, this should give you an idea of what company's own insiders consider a good price for the stock.


Heavy Competition

Some markets face tough competition, if your company makes the bulk of their income in a highly competitive market be aware that the potential for profits is much reduced. Make sure you understand how this factor affects the stock you are planning to buy.


Small Caps and Big Caps: the potential to go bust

Small companies have a higher risk profile than larger companies simply because of their size. If the creditors pull out it will be hard to replace them when you have limited resources and a shorter time-record. Size is a double-edged sword, smaller companies tend to go broke more often, but they also perform far better than larger companies whose price rises more slowly.

The key here is to be aware of the type of company you are buying, and if its a small cap make sure they have a healthy balance sheet with lots of assets and few liabilities. That way the company can more easily weather periods without credit, or if worse comes to worst and they go into liquidation there is sure to be something left for the investors after creditors take their part.


Accounts Not Audited

Finally, and if anything the most important factor of all: Is the company cooking the books?

You can find out if a company is being audited by looking at their last annual report. Go to their website, look for investor relations and download the document, then search for "audit" and cross your fingers in hope of a reputable auditor.

Companies who are not being audited have a free licence for creative accounting, while your company may not be one of these you need to understand the risk. Generally more developed economies will have stricter accounting regulations and less incentives to "add a zero" here and there. If you are buying stocks in an unaudited company in a third world country dont be surprised if there is something fishy to be found in the books.


Getting Ready to Buy.

By now and if you have considered all the factors above, you should have sufficient understanding of the sorts of risks you are entering into by purchasing your chosen stock.

Remember to look at the pattern of recent price movements. If a stock has underperformed the index in recent months its probably a good time to buy since it will be trading relatively cheaply, but be wary of persistent down-trends, generally its safer to buy when a stock has "levelled out", rather than when the price is free-falling.

Also, where possible, decide at which price you are going to buy and stick to it by using "limit" orders at a fixed price. This becomes more important when trading stocks in smaller companies with poor liquidity (few shares changing hands every day), since orders at market price can actually affect the market and distort the purchase price by as much as 10-20%.

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