If you have ever considered or considering buying a share or a stock, this article is for you.
The team at MoneyInAfrica has bought many shares/stocks across the African continent over many years, and some have done very well (kudos to Safaricom, Dangote Cement) and others have brought us to tears and near financial loss (thanks Uganda Clays and Mumias).
The joys and lows of these experiences have not been wasted and have taught us a lot about what to do before we go and commit our hard earned money to investing in a share/stock.
What we have learnt can be summarised into seven questions. When we have answered these questions honestly about a company, we have profited; and where we have taken shortcuts, our investments have performed poorly.
By answering these questions, we are able to understand whether the company we might want to invest in has a good track record and has a bright future ahead that will make us lots of money or vice versa.
Let us find out what questions will separate the income generating shares/stocks from those income destroying ones.
7 Questions you must ask before buying a share/stock
1. Do I understand the business of the company?
Investing in shares/stock is simply the buying an ownership piece of a company with an expectation that your stake will go up in value over time and you will also receive dividends from the profits.
Therefore it is critical that you understand the business of the company - how it makes money. Does it make money from manufacturing and selling products, providing services, lending customers, renting property, commission based revenue etc.
If you invest by following the advice of so-called experts or stock tips, you’re likely to be extremely disappointed because you may not fully understand why they recommend it, what factors affect its success, and really where the money is being made.
Investing into a business you don't understand is akin to gambling with just less excitement.
Don't just rely on our word but also on the world's greatest investor yet - Warren Buffett
"Never invest in a business you cannot understand"
- Warren Buffett
2. Do I know and trust the people running the company?
Most times when you buy shares/stocks you will be buying into a business ran by other people not necessarily yourself.
When you buy a share, the Board of Directors and senior management of the company will be the people in charge of ensuring that your investment is fruitful. The Board of Directors and Senior Management make the decisions that shape the future of the company and therefore your investment.
Once you understand how the company makes money, next thing you to make sure is that the people running the company also know what they are doing.
"When money realizes that it is in good hands, it wants to stay and multiply in those hands." Idowu Koyenikan
3. Do I know who I am investing with?
When you buy shares, you become a one of the company's shareholders. As a shareholder you have a right to make decisions about the company including who sits on the Board of Directors.
Your vote is usually equal to your proportion of shares in the company. If you are not the majority shareholder then it is important to know who the big shareholders because they influence the major decisions.
If their is a single majority shareholder then you are investing in her/his vision, if government is the largest shareholder then you need to watch the politics closely, and if it is a foreign investor will they push for high dividends so they can repatriate funds.
The actions of shareholders are the reason why share prices go up and down, irrespective of how the business performs
4. Does this company make money?
Successful companies make profitable shares, and successful companies make money. Unless a company makes good sales and is profitable, there is little chance its share price will grow or have any money to pay out as dividends.
Before a company can make you any money you need to understand if it is making money itself. Is the company growing its sales are those sales profitable and can it maintain that.
The past is not a predictor of the future but a good track record indicates what is possible.
"What makes stocks valuable in the long run isn't the market. It's the profitability of the shares in the companies you own. As corporate profits increase, corporations become more valuable and sooner or later, their shares will sell for a higher price." Peter Lynch
5. Has the company made money for investors?
The reason you buy shares is to make money either by getting regular dividends or growth in share price.
Therefore it is critical to understand if the company you are buying shares into has a track record of regular dividends or share price growth. If it doesn't do you understand why.
A company without a track record for generating money for investors is either one at early stage of growth or one that is going through a tough period. This doesn't mean that it won't be be a success in the future of recover from a slump- but is your investment goals and horizons willing to wait.
If a company is not making money for other investors, will you be the Special One?
6. Is the company financially stable?
The perfect share makes you money from when you start investing, and continues to do so in the future.
For a share to make money, the company must be financial stable to continually generate higher revenues and profits that will drive up its share price and pay out dividends.
A company that is not financially stable is usually on the defensive and will look to increase profitability by cost-cutting and reducing dividends rather than growing its business. If the business is not growing, share price will usually suffer and if cost-cutting is driving profitability this can only go so far before there is nothing left to pay out as dividends.
7. How is the management increasing company value?
As we have mentioned before, it is good to know who is in charge of managing the success of your company - as a shareholder it is your company.
The job of the management is to "sweat" the assets of the business - make the as much profit using the assets available, and sustainably increase the value of your stake in the company.
Once you know who is running the company, also make sure that you are happy with way that they are running the company.
"When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever." Warren
Start answering these questions
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