Questions to ask BEFORE you buy a share

People do not do too much research before they buy shares – I am talking of the new investor! I met a few people who had gone long on Options of PSU banks and made a lot of money. They do not realize that it was SHEER LUCK – and it could have gone the other way too. Sadly not enough people can distinguish between luck and skill.

Well here are a few questions to ask before you buy a share in which you wish to invest (remember this is not research, this is pre-research!!). These questions are necessary, and basic – nowhere near sufficient, but a good starting point nevertheless!

  1. What business is the company in? What does the company do? – If Warren Buffett has his circle of competence, so should you. Indigo runs an airline, asian paints makes paints, Hdfc is a bank. Well none of the business is very easy to understand, at least it is easy to describe. If you do not understand what a Selan exploration or a Motherson Sumi does, do not buy. If you must buy, you must understand what it does. Siemens, Cummins, Hindustan oil exploration, Apollo hospital – see what it does before you buy the share.
  2. Is the company paying dividend or at least is it paying Income Tax? – investing in companies yet to make profits is not a sensible thing to do for a retail investor. Let the Venture capitalists invest in turn around companies – it is a different kind of skill which you and I will not be able to match. If it is profitable and paying Income taxes it will pay dividends soon, so you can relax. To be even safer invest only in companies which are dividend paying companies. At least you know that the cash flows that you see are genuine.
  3. Historically how has the company behaved? – see the immediate past 2 years. Read the quarterly reports, and scan last 3 years balance sheet and director’s reports. See if the company could see into the future, did they predict what happened? Check out what they said and what they did. See if you can find out whether the company got lucky or was it strategy. Not easy, but do make an effort.
  4. At what Price Earnings is it quoting? Pe of 24 and above is considered high – but we have been at a high for a long time now. Let it be clear that we are at the top end of a market now. Of course there are some companies available at a lower PE, and they may be growing slowly too! so look for a pe is say around 17 and not 24! Remember that the market can be at a new high pe for a long time, and can lull you into believing that ‘this is the new normal’ – using PE is a double edged sword, but a good place to start nevertheless.
  5. Who are the competitors and how are they priced? If you are seeing Asian Paints you will also see Berger Paints. It will be difficult, if not impossible to come away thinking ‘these are 2 awesome companies’. So if you see the whole industry is at a high PE, you may start rethinking your view on that industry and its valuation.¬†Does this company have the big market share (does not happen in IT or pharma remember that) in its industry? Is it a niche player in a competitive industry? Is it an industry dominated by one company, or is it a fragmented industry where even the biggest player controls less than 10% of the market — like what you will see in case of D’Mart or other supermarkets. Also, pay attention to foreign competition! Its real and ruthless.
  6. Who runs the company? I prefer family run business like Cholamandalam, Asian Paints, etc. which have competent management and good family values. Nothing to say that ITC is not a great business. Or that Equitas will not be well run by a bunch of friends who knew each other for a long time!
  7. What is the dividend paying out policy – if you buy a psu share, the government will chase the company for a high dividend! That means you benefit too. However some companies may decide to keep a big portion for their own future use, be wary.
  8. There are 9000 listed companies. About 5000 of them are seen occasionally. About 200 have trustworthy balance sheets. There is no point for the retail shareholder to go beyond these 200 shares. Stay away from the sme exchanges, etc. stick to NSE top 100 or the bse top 200. No point in going beyond this huge basket.
  9. Any red flags that you saw recently? director prosecuted for non payment of tax? or some such criminal or social mistakes/ frauds? stay away
  10. Is the company still competitive and thriving? Reliance power and Reliance Communication are not great examples to have in your portfolio, right?

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One Response to “Questions to ask BEFORE you buy a share”

  1. Hi Subra,

    Isn’t this list of questions to be kept handy and use it while you are reviewing your equity portfolio? and not just before buying shares of a company and forgetting about it entirely.

    Thank you!

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