5 Questions To Ask Whenever Anybody Recommends A Stock
Many a times we come across a lot of people who recommend us to buy stocks. One of the biggest problems that we face is that everyone thinks themselves to be an investment expert, especially when it comes to stock markets. Sometimes one can see that even a ‘Paan-wala’ has a view about the markets and stocks or the both of them. With such a situation,, one needs to be very careful. Following are a few questions which could help one resolve such a situation.
1) What does the company do? What is the objective of the investment--value, growth or income? And why do you think the investment suits you?
If you don't understand the company's business, pass it on. If you're still intrigued, go on with that. If you are an income-oriented investor, that is, someone who needs regular dividends or interest, you can quickly eliminate the so-called growth stocks, which has great appreciation potential but you do not need to pay current income.
2) What are the prospects and competition in the company's industry? Where is the company positioned?
Is it a leader, an upstart, a niche player, or somewhere in the middle of the pack? Investing in the growing industries is less risky than investing in companies that are battling at the bottom of a shrinking market.
3) What is the company's earning and revenue history for the past five (or 10) years? And does the company pay a dividend?
A company that has been able to boost sales and earnings in good times and bad is clearly less risky than the one that has an inconsistent history. If the company has been paying dividends, one needs to find out if the dividends are consistent, or rising, or falling or do they vary year-to-year? And what is the dividend yield? (That's the cash dividend that is divided by the market price. In other words, if the company's stock sells for Rs.100 per share and each share pays Rs. 5 in annual cash dividends, the dividend yield is about 5%.) It's generally less risky to invest in companies that pay relatively generous dividends because the dividend can attract investors to the stock.
4) What is the company's price-earnings ratio and how is the ratio compared to the company's projected growth rate?
That's the market price divided by its per-share earnings. A company selling for Rs.100 that earned Rs.10 per share would have a price-earnings ratio of about 10. And how does that compare to its average price-earnings ratio over the past five to 10 years? If the company's price-earnings ratio is comparatively low, it might be a possibility that they are selling the stocks at a bargain price. And if it is higher than the average, you have to know the changes in the company's prospects to warrant the lofty market value. If the company's shares are selling 30 times of the current earnings, you should expect the company to be growing at a 30% pace, Johnson (who is Johnson?) says. Otherwise, it's going to take a long time for your investment to pay off.
5) Do you have research reports and other printed material on any website that I can look at, before I make an investment decision?
Ideally, you want the investment houses' research reports on the company and the industry. You want independent research, such as a Value Line report. And you want printed material from the company, including an annual report, 10-K and quarterly reports.
People who can answer all these questions have done their homework.
Once you do yours, by reading the materials that they have mailed, you're in a great position to make a good investment decision.
Of course, that doesn't mean you'll never lose money on another share of stock. But you will have a lot of knowledge about it.
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