A SIMPLE CHECKLIST FOR INVESTING IN SHARES

There are thousands of opportunities available to us today to invest in shares. Anyone with access to a smart phone and an internet connection can now build wealth by buying shares in companies across the world. A share or stock is a piece of ownership in a listed company. The following considerations should be taken into account before buying any stock:

1. Is the company profitable?

We need to check if the company is profitable and has been profitable for the last three to five years. Stay away from companies making losses. You should also check if profits or earnings have grown steadily in the past. Check also if gross and net profit margins are reasonable compared to existing returns on simple treasury bonds. Also compare how the company’s profitability compares with peers, the industry, and the general economy in which in operates. Check whether the return on equity and assets is meaningful and growing. The higher the return on equity the better.

2. Is the share price reasonable?

To evaluate whether the price is reasonable we need to compare it to earnings or profits per share through a ratio called a price/earnings ratio. A high ratio implies that the stock maybe over priced. We should compare to book value, and the higher this figure the more expensive the stock. Ultimately we want to figure out the fair value or intrinsic value of the business and then compare it to the share price. A good share price is one which is significantly discounted to the intrinsic value. Such a discount is often referred to as a margin of safety.

3. Does the company pay a dividend?

A company which pays a dividend is often better than one which doesn’t. So check if dividends have been consistent in the past or even growing. Check if the dividend payout is reasonable and if the dividend yield is meaningful. The dividend yield is obtained by comparing the dividend per share with the share price. A meaningful dividend yield is one which exceeds what you would earn on a simple unit trust or treasury bill/bond.

4. Are future prospects good?

When you buy shares in a company you are ultimately investing in the future prospects of the business. So check if the company is growing and is an industry which is growing. Be careful of buying shares in companies which are projected to decline in earnings, sales, and market share. A good business to buy is generally well positioned to take advantage of the big macro economic trends happening in the market in which it operates.

5. Is the company in a good financial position?

Check if debt levels are low and if the company is able to meet its debt obligations. Also ensure that short terms assets more than offset short and long term obligations. The business should also have a positive equity. Check that the business generates a positive cash flow and cash balances are positive.

Ultimately what we are trying to do is invest in a solid business, with good future prospects at a reasonable price. The idea is to find a basket of such stocks and diversify our shareholding over time. Such a portfolio can really compound over time and enable us achieve financial independence.