Investment questions - part 1

Like mentioned in earlier articles, investing is not just buying and selling of shares, but buying or selling of (a part of) a company. This means that you need to have a clear picture about the company. It is essential to know what the company does, with what activities it earns money and who decides about the direction of the company. This article hands questions that can be asked to gather information about a company and to draw a picture of the company. To keep track of the short-term performance of shares, a question about the current sentiment is discussed.

Is the company large or small?

Smaller companies do run the risk that a wrong decision or a negative development (in the market) have a great impact on the profits. Missing a large order can cause the collapse of a small company, while for a company with lots of large orders a year, this will only cause lower profits. This vulnerability of small companies results in a lower P/E ratio for companies traded on local markets compared to companies traded that is part of the main index.

Which company benefits the most of the current economical situation?

To answer this question, you will have to know which industry benefits from which economical situation. Companies that have the most advantages of the rising of the economy are mainly the the companies which have an high cost base, companies with high investment costs. Examples are companies operating in the mining industry or heavy industries. These sectors will be among the hardest hit industries in an economic downfall. Companies with high fixed costs are historically cyclical stocks.

Companies that are hit first during an economic decline, but also benefit the first, are detachment agencies. During an economic decline, personnel without a contract will be laid off first when profits begin to fall. But when an economical recovery is near, these people will be the first who are hired.

When you know which companies will be the best performers in the current economical situation, you will have to think one step further. The questions you can ask yourself are:The questions you can ask yourself are:

  • What will be the next stage of the economical wave, and when will this stage begin?
  • Which companies will benefit the most from this new economical situation?

How competetive is the market in which the company operates?

To answer this question, you have to ask yourself a few other questions, namely:

How many competitors are delivering the market? And how easy can the company enter other markets or can new competitors enter the market? When a new competitor can enter the market with little effort, the profitability of the company will be under pressure. Favorite investments should be companies that have virtually no competitors, because these companies can get the price they ask.. So, the less competitors and the harder it is for new companies to enter the market, the better an investment a company should be.

What kind of company do you deal with?

It is important to know what type of company you are investing in. Does the company has a stable growth of profits, or does the profit unpredictably changes each year? Besides that, can you be sure that the profits will be on the same level for a long time, or will the profits decline? A few types of companies can be identified, which can give you a rough understanding of the type of profitability of the company:

  • Growth shares are shares of companies which can show a strong growth each year because of their strong market position and good management. Often these companies are operating in a mature market and show a stable growth year after year.
  • Normal shares have show an average profit growth between 0 and 10%.
  • Cyclical companies have strongly fluctuating profit. This is mainly because such companies have high fixed costs and will notice every bump in the economy.
  • Start-ups are companies that have initially low profits or even losses. After a maximum of a few years it should be clear whether the company can be successful or not. A start-up provides a good perspective, but might as well be a failure. It is therefore of great importance to know exactly what the company does exactly.
  • Nearly bankrupt companies are very risky, but can deliver a nice return when the company is shuffled. So, the company must have some potential, and a clear picture of the company is also necessary with these type of companies.

How does everyone else think about the company?

When a lot of banks and investors a feeling negative about the company, a lot of possible bed news is discounted in the stock price. On the internet you can find a lot of information about the expectations of different people. If the bad news is already discounted in the price, future news can have a positive impact on the price, even if it is not good news. So if a lot of people feel bad about a company, it could be profitable to take a good look at the company.

How experienced and talented (and fair) is the management of the company?

This question will not be answered the same by everybody, that is why it is important to answer this question all by yourself. A well led company will always be a better investment than a company whit unfair people in management. That is why you should judge the management of a company. When management changes, you should assess management and the company again. Peter Lynch ones said: “When a poorly led company still makes money, what should it earn when the company was led well?”. It is hard to assess what good management is, but you can learn a lot about the interviews with management in newspapers, internet and other investment sources. The next factors should be watched closely:

  • Management may not receive extraordinary high salaries. Option bonuses are preferred above high fixed salaries, because this way management and investors have common interests. But a reward that is too large will not be beneficial for stock prices.
  • Returns on investments can be benchmarked with competitors. Historical returns of the current management can be marketed with other companies.
  • Management can handle critical opinions. The personal life of an CEO can tell a lot about his mentality. Remarrying with a young woman can mean that the CEO cannot stand critical opinions.
  • Management with lots of secondary activities, for example in politics, indicates the self centeredness of these persons. This also means they cannot be fully involved in the company, because they must spend time to the other activities.