Written By: Anna Johansson
If you’re new to the world of investing, you may experience a range of emotions when considering your next stock pick. You’ll be excited at the prospect of beating market averages, or worried about the possibility of losing your money. Whenever a piece of news or a local trend makes you consider a new stock for your portfolio, you’ll alternate between enthusiasm and apprehension, unable perhaps to make a quick decision.
There’s nothing wrong with thinking through your choices, so long as you’re doing it effectively (and avoiding analysis paralysis). The next time you find yourself toying with a new investment opportunity, there’s a series of critical, directed questions you can ask in order to act more decisively.
Questions to Ask
Before buying that alluring investment opportunity, ask the following questions:
1. Does everyone else think this is a good opportunity? You shouldn’t base your entire strategy on public opinion, but evaluating others’ thoughts on this investment is an important step in your analysis. If a stock is universally reviled, ask yourself why. If it’s universally adored, ask yourself why. Sometimes, a “sure bet” in the mind of the public is actually a bad investment; remember, prices are determined by market activity, so if everybody believes a company is an amazing investment opportunity, it could push the price artificially high.
2. How much money are you willing to lose? You should never invest more in a single stock than you’re willing to lose. If you’re confident you could lose, say, $5,000 on stock for a given company and still walk away with a strong portfolio, you can continue making conservative decisions for your future. If you’re afraid of losing the money, consider investing a smaller amount, especially if you’re inexperienced.
3. What’s the competition like? Every company has competition. If you’re only looking at a single business in a given industry, search for their contemporaries. Which other startups are doing what they do? What are their advantages and disadvantages? These questions can help you understand your investment target’s place in the world, and whether they’re truly an outlier.
4. What is the trading volume? Trading volume refers to the number of shares available in this company. The higher this number, the more stable the price may be, and the more liquid the investment is likely to be. If your investment opportunity has a suspiciously low trading volume, it may be cause for concern.
5. How has the price fluctuated in the past? Take a look at the price changes for this investment over the past few years (if the data are available). Sharp fluctuations should prepare you for an uncertain future, and historical prices should inform you whether this is currently a relatively cheap or expensive buy.
6. Who’s in charge? The people in charge of a company will decide that company’s future, through their direct orders, their public-facing interactions, and their effects on company culture. Ask yourself whether this leader has past leadership experience, what their style is, and how they might impact the future of the company.
7. What’s the rest of your portfolio like? Is this your first investment? You might be better off investing in an ETF. Is your portfolio already full of companies in this industry? It may be time to round out your portfolio with something different.
8. How does the company make money? This may seem like an obvious question, but it’s one that often goes neglected. For example, the company may make lots of revenue by selling a flagship product, but if their expenses are too high, their profitability could be compromised. And if their entire operation is banking on some future development or a change in consumer trends, things could get ugly if that prediction doesn’t come true.
9. What are the biggest threats? No investment is a truly safe bet. Every business has key threats, whether they come in the form of competition, regulation changes, or new developments in consumer behavior. It’s important to proactively identify these threats so you’re prepared for the worst-case scenario (and to give you a better high-level context for the nature of the business).
10. When would you sell, hypothetically? Finally, think about when you might sell this asset. Are you planning on holding it forever? Are you hoping for it to reach a certain price target? What if the price starts dropping—would you sell at a certain point?
On Making Mistakes
In investing, it’s not important to have 100 percent of your decisions be successful or profitable—in fact, such an outcome is impossible. Instead, rather than dwelling on your inevitable mistakes, try to learn from them, so you have even more information to make good decisions in the future. Even after asking these critical questions of your investment opportunities, be prepared for a few losers in your portfolio, and diversify your portfolio accordingly. Gather all the information you can, and make a firm decision based on that information; it’s better to research, act, and lose than to never try investing in the first place.
DISCLOSURE: I do not have any financial interests (ie. compensation, long or short positions, employment, etc.) in the companies discussed in this article.
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