6 Things To Consider Before Buying A Company’s Shares

When you purchase a company’s shares, you’re actually buying a part of its fortunes. When it records significant gains, you’ll get a good return on your investment. But if it bleeds losses, you could loose part of your money. In effect, you’re in it for better or for worse. Unfortunately, many people don’t quite understand this. They’re told that shares are a one-way ticket to bulging-cash-purse-land; but they are only vaguely aware of the risks involved with staking their money on potentially volatile financial instruments. So they dive into it unprepared. If they’re lucky, they’ll emerge unscathed, perhaps even clutching handsome returns. But when the stock market isn’t pleasant, such poorly informed decisions may be punished with scorching severity.

A lesson from 2008

This happened on a market-wide scale in 2008. In the decade preceding that year’s stock market crash, investors – individual and corporate – had poured their money into shares. They were attracted by the fantastic returns boasted by stocks listed on the Nigerian Stock Exchange (NSE)- in certain cases, share values were quadrupling in less than a year. It all seemed like heaven, with an unending stream of easy profits. Then the global financial crisis happened; investors panicked, and a mass sell off of shares ensued. Because most people were selling and not many were buying, the value of shares plunged sharply. Gains built up over years were wiped out in a couple of months. Millions lost fortunes. However, owning shares is still a good idea. Nigeria has just emerged from a recession, the stock market is doing alright, and there are companies offering modest returns on investment. You just have to know how to choose the right shares to buy. Fortunately, this can be done.

Things you should look out for

Here are a number of things you should consider before making the move to purchase a company’s stocks.

1. The sector in which the company operates

If you’re thinking about buying a company’s shares, you should find out what their industry looks like. Is it stable and thriving, or fragile and prone to shocks? Is it serving a visible and growing market? What are it’s prospects for the near future? Examine the competition as well. How are they faring, compared to the company which you’re looking to buy stocks from? How is market share split up between businesses in that industry? Do they come off as innovative and forward thrusting? How stiff is the rivalry within the space, and how does it play out? Knowing the industry in which you’re investing helps you respond properly to any signals from it. For example, if you’re putting your funds into a company that’s a clear leader in a bouyant sector, there’s a good chance that your investments will yield appreciable returns. But if your shares are from a business struggling in a space crowded by bigger competition, opportunities for growth wil be limited, as will the likelihood of taking profits from shares in that business.

2. Revenues and profits

Publicly traded companies typically publish their earnings report on a quarterly or annual basis. In these reports you’ll find such information as the company’s net income and per share earnings. Go through the reports, review these figures, and determine if the profit margins are decent enough for you. It’s also wise to compare the company’s earnings over time. If the general trend is an increase in value, investing in its shares might be a good idea. But if the changes in earnings over time has been negligible or negative, you’d be better off staying away from it. These days, publicly traded companies publish their reports online, so you can download them from their websites. An indicator of company health is the sales it’s able to make. Higher sales figures shold lead to more revenues, and ultimately more profits, if taxes, operating costs and other deductions remain fairly stable. Since good Return on Investment (ROI) is dependent upon the growth of the company in which investment is made, you’ll want to go for shares in businesses with consistently increasing sales.

4. Balance sheet

This is a record of the company’s assets, liabilities and shareholders’ equity at a particular point in time. It’s in effect a snapshot of the company’s financial position at the time it reports on. And this is why it’s crucial. The balance sheet gives you an insight into the company’s debt, inventory levels, and liquidity. If you’re able to scruitinize these as individual items and in comparism with what they were in previous reports, you’ll have a good idea how the company is faring, and where it’s likely headed. Avoid buying shares of businesses that have balooning debts, or poor liquidity; they’re sitting on a keg of gun powder. Opt for those with declining debt, stable inventory levels, and healthy cash flow. Maybe a lot of this looks like Greek to you. If it does, you should seek the services of a person versed in financial accounting to help you out.

5. Management

Learn what you can about the people running the company. Do they have a good track record? Have they steered the company to strong growth? How have they managed it’s affairs? Don’t be a shareholder of a business that’s managed by people who obviously aren’t driving it properly. Save yourself the pain of an expensive crash, and invest in a company with competent leaders who take their brand and their shareholders seriously.

6. Value of shares over time

Pick shares that have consistently risen in value over long periods. You might be tempted to place bets on historically low performing stocks if there’s widespread talk of them coming alive for some reason. But before you do this, be absolutely certain that there’s some substance to such claims. In the end, caution is always the best principle to adopt in these situations.