The Ten Point Checklist For Buying Stocks
People buy stocks for different reasons. Some investors buy a stock strictly on “technical” reasons based on chart patterns and trends, some buy a stock because they read an article or saw an interview where some “expert” recommended a stock, others buy a stock because I talked about it on 20s Money.
All of the above reasons can be good reasons at different times (especially the 20s Money reason); however, this post will provide you with a checklist for you to walk through whenever you are considering purchasing a stock. Hopefully this will help you eliminate buying stocks for wrong reasons and help you make more money!
If you think you found a stock that you want to buy, do a quick run through the following check points. Does your stock pass the test?
#1 – Does your stock pass the owning a company vs. owning a stock test?
If you had a friend that offered you a stake in a company (the stock of the company you are considering buying), would you purchase an ownership stake? It is important to recognize that by purchasing stock you are buying ownership in a company. How would you research a company you were considering becoming an owner of? You’d probably research the management, its products or services that it sells, its capital structure, etc. You should do the same with a stock.
#2 – Do you understand the services or products the company sells?
For me, I don’t understand banks very well. Derivatives, securities, other financial instruments, blah, blah, blah. I prefer a company like Philip Morris; they sell cigarettes and do a great job doing it. Or Apple, I use almost all of their products, in fact, I’m an indirect salesman of Apple products. I am always selling my friends on why they need the latest Apple product. Clearly, I understand them. Buy stocks of companies that you understand.
#3 – Do you understand the basics of the company’s financial state?
Learn how to read a basic balance sheet and income statement, then analyze them for this company. Is the company heavily in debt? Does the company finance its growth through cash flow from operations?
#4 – Is the corresponding sector poised to outperform?
The company can have great leadership and great market share, but if the overall market they are a part of is poised to drastically shrink, you’d better steer clear. For example, would you invest in a leading company that produces VCRs? Of course not.
#5 – Is their market domestic or global?
Who are the customers for the company? If they are limited to American companies or individuals, you may want to reconsider as economic conditions domestically are fairly ugly. I like companies that sell their products and services globally.
#6 – How would your react if your stock goes down after you purchase the stock?
Would you panic and sell? If so, you obviously did not have much conviction in your initial buy. If you would buy more, then obviously you’re a believer in the long term value of the stock. I frequently will purchase only a chunk of my overall position that I want to accumulate in my first buy so that if over the short term, the stock goes down, I can purchase more.
#7 – Why do you think this company will make you money?
Can you explain to someone in 30 seconds why you are buying this stock. Here’s a hint: to make money. Do you expect growing dividend payouts over the years or are you counting on share price appreciation? Why will the share price appreciate?
#8 – Are you investing in this company for the sake of diversification or because you like the company?
Would you buy this stock if you could only buy one stock? Buying a bank because you aren’t exposed to the financial sector is not a good reason. Don’t buy a stock simply to help you diversify; buy a stock because they are going to outperform and make you money.
#9 – Would you recommend the stock to a family member?
This is a great test to see how much conviction you have in buying this stock. If you recommend a stock to your father and it loses value, you’ll regret the recommendation. Can you recommend this stock? Would you recommend to buy more if the stock goes down in the near term?
#10 – What is your exit strategy?
This is often overlooked. Profits on paper are meaningless. Do you have a targeted share price you want to reach before selling all or part of your position? If you reach your target share price, stick to your initial plan and cash out at least some of your position.
Do you plan to hold this stock indefinitely to collect dividend payouts? Will you reinvest the dividends or take the cash and deploy elsewhere?
Implement this checklist
While this checklist is by no means exhaustive, it will certainly help you begin your thought process when making a decision to buy a specific stock or not.
Are there any points on your mental checklist when you buy a stock that are not listed here? Add them to the list by adding a comment!