When it comes to picking individual companies to invest in, it can get tricky. There are so many companies out there, so how do you know which one is good or bad? Well, there is no way to tell for sure if a company is good or bad after all we can’t see the future. But there are definitely ways to look into a company that will increase your odds of picking a winner. In this post, I’m going to share 5 things for you to consider when picking a company to invest in to increase your odds of finding a winner.
Disclaimer: None of the information mentioned in this post should be considered as financial advice. It is only a guideline to help you make a more informed decision.
1. Do You Know Anything About the Industry the Company Is In?
When it comes to investing in individual companies, you shouldn’t invest in what you don’t know. The reason why is because you can’t really tell if a company is going through real trouble or not. So, you might think well you’ll know if the company is doing badly when the stock price is dropping. To some degree that is true, but if you don’t really understand what the company is working on then can you really distinguish if what is happening a short-term blip or will it impact the company for years to come? If it is short-term, it’s like the stock is on a discount and if it was something long-term maybe you might want to exit your position. Without any knowledge on the company or the industry it is in, it would be really difficult to tell and you’ll feel like you’re strapped along for the ride.
2. Is the Company at Risk of Being Disrupted?
Have you ever thought to yourself what happened to company X? I remember seeing them everywhere a few years ago and now I don’t see company X around anymore. Don’t let that be the type of company you invest your hard-earned money into. Companies that are not around anymore tend to be companies that got disrupted by new advancement and they didn’t manage to keep up. Take for example the transition of flip phones to smartphones and brick and mortar stores to online shopping. There are a lot of transitions happening over time, so make sure the companies you’re investing in is at the correct side of the transition.
3. Does the Company Keep up With Innovation?
Do you ever wonder why some big-name companies are around for hundreds of years while other big-name companies just disappear? One of the biggest reasons is that they don’t keep up with innovation. Those companies established a working model then they think the money will just keep coming in. They are aware of what is happening in their space and the transition that is happening, but since everything is still working, they keep doing what they are doing.
So, what do you think happens to these companies that don’t keep up as the transition is happening? In most cases, the money stop coming in and they scrambled to catch up. Most will fail to catch up because they would be years behind the competition. So, it is really important to keep up with the trends of the industry and see if the company you want to invest in makes an effort to invest in the new trends.
4. What Is the Valuation of the Company?
Is the company trading too rich? Did the market already priced in too much good news and growth and now the company needs to live up to the expectation? How does the forward P/E (price to earnings) ratio look? For large-cap companies that are still growing, a forward P/E ratio of around 20 would mean the stock is probably around a fair price. When the forward P/E ratio is really high, you’ll need to do some research into why that is the case.
Here is an example of the valuation of Facebook from yahoo finance on 6/17/2020.
Notice that the current forward P/E ratio is much higher than any time in the past year. So, if you were interested in Facebook, you really need to look into why it is trading so much higher. So let’s say you did your research and you found out that Facebook’s products have gained a huge jump in usage due to a recent change in trend and the trend looks like it will last. In that case, although the forward P/E is high, Facebook can still be a good investment.
On the other hand, if after you did your research and nothing happened with Facebook and there are no external factors affecting Facebook either then you might want to hold off on buying. Being patient and looking for discount opportunities will make a big difference in your return on investment.
5. How Is the Company’s Balance Sheet?
How much debt or liabilities a company has will usually give you a rough idea of how well they will be able to survive through tough times like a recession. Does the company have no debt? Do their asset and debt roughly match? Do the debt outsize their assets by a large amount? Usually, you want to keep an eye out for debt that is much larger than assets because when something bad happens the company can be at risk of not being able to pay off their debt. This would usually lead the company down the path of bankruptcy.
Let’s take a look at an example of a good balance sheet. This is the quarterly balance sheet of Facebook:
Notice how they have plenty of cash compared to their debt. Should anything bad happens, Facebook can easily pay down their debt and have excess cash to continue operating.
Now let’s look at a terrible balance sheet. This the quarterly balance sheet of American Airlines:
Notice how they only have $3.576 billion in cash while their debt is a sky-high $34 billion. If anything bad happens, how in the world would the company be able to pay back their debt? In most cases, without any government support, the company would go bankrupt and not make a turnaround. In fact, if you look at American Airlines’ history, they had filed for bankruptcy in 2011.
I hope this post was helpful to you. If you found this post helpful, share it with others so they can benefit too.
To learn more about actionable steps you can take during a bear market you can check out my post on navigating a bear market. If you’re new to investing and need a guideline to help you start your investment journey you can check out my post on setting yourself up for financial success.
To get in touch, follow me on Twitter, leave a comment, or send me an email at steven@brightdevelopers.com.
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