Questions you should ask when selecting stocks
The process of selecting stock to invest in can be overwhelming and confusing.However by asking some important key questions you can determine if a stock is a good investment for you.Here is some of he questions you should ask when selecting stocks-
- How much cash is generated by the business and when is it generated?It is crucial that once the investor has identified the sources of cash in a business that he or she also estimates the amount of timing of the cash flows. This will help you determine because of the time value of money how valuable the business will be in the future.Remember that investing is always about time.
- Where is the money coming from? Before an investor can clearly value a business he will have to know what is generating the cash flow.Experts advise that it is important to be specific and avoid making assumptions.
- Is the businesses cash flow sustainable? It is crucial to remember that just because a business is considered blue chip stock today it may not be in the years to come. For example many investors felt that the long history of industry profitability in some markets led many to believe that certain businesses would always be solid as a rock. The savviest investors, however, realized that past history was of no value in projecting future cash flows due to a constant shift in the competitive landscape. One of the best ways to evaluate the sustainability of cash flows is to examine the barriers of entry for the market or markets in which the company operates. It is important to ask if it is going to be much more difficult for a competitor to enter a business which requires hundreds of millions of dollars in startup capital than for example then it is for a retailer, which can be opened for a miniscule fraction of the cost.
- How much capital does the business require to operate? The reality is that some businesses require more capital to generate one dollar of profits than others. For example, a steel mill requires huge investments in property, plant and equipment and then produces a product that is a commodity. On the other hand an advertising firm requires very little capital expenditure to keep the business going, generating tons of cash for the owners relative to investment. The bottom line is the less capital a business requires to run; the more attractive it is to an investor.
- Does management of the business have a shareholder-friendly orientation? Financial experts aggress that the way management treats shareholders is the single most qualitative determinant of success. An upper management structure that is willing to push for share repurchases when a company's stock has fallen rather than acquire another business is much more likely to create wealth than one who is bent on expanding the empire.
- Are the management's actions in the business consistent with what they say in their public communications? You will want to make sure that the management not only "talks the talk but walks the walk". If they do not they are not being hones. As an investor (and thereby a business owner) you only want to be in partnership with those whose actions match their promises.
Is the price of the businesses stock attractive? There is no denying that price is the absolute determinant of return. A disciplined investor will determine if the price is attractive in relation to the potential rate of return.Only by determining if the stock is correctly priced can the investor make an educated decision if the investment is right for them.