4 Things to Look for in an Investment
The most important qualities every good
New investors are often interested in purchasing
a company's stock but are not sure where to begin. These four
characteristics should serve as helpful guidelines in your
search for a good investment.
1. What is the price of the entire company?
When doing research, it is important that you
look at more than just the current share price - you need to
look at the price of the entire company. The "cost" of acquiring
the entire corporation is called market capitalization (or
market cap for short) and is frequently referred to by financial
professionals. In short, the market cap is the price of all
outstanding shares of common stock multiplied by the quoted
price per share at any given moment in time. A business with one
million shares outstanding and a stock price of $50 per share
would have a market cap of $50 million.
This market capitalization test can help keep
you from overpaying for a stock. Consider the case of eBay and
General Motors during the heyday of the Internet era. At one
point during the boom, eBay had the same market cap as the
entire General Motors Corporation. To put that into perspective,
in fiscal 2000, General Motors made $3.96 billion dollars in
profit, while eBay made only $48.3 million (not including stock
option expense!). Yet were you to buy either one, you would have
had to pay the same amount. It is almost unbelievable that any
sane investor would pay the same price for both companies but
the general public was seduced by visions of quick profits and
Another useful tool to help gauge the relative
cost of a stock is the price to earnings ratio (or p/e ratio for
short). It provides a valuable standard of comparison for
alternative investment opportunities.
2. Is the company buying back shares?
One of the most important keys to investing is
that overall corporate growth is not as important as
per-share growth. A company could have the same profit,
sales, and revenue for five consecutive years, but create large
returns for investors by reducing the total number of
To put it into simpler terms, think of your
investment like a large pizza. Each slice represents one share
of stock. Would you rather have part of a pizza that was cut
into ten slices or one that was cut into eight slices? The pizza
that was only cut into eight parts will have bigger slices with
more cheese and toppings.
The same principle is true in business. A
shareholder should desire a management that has an active policy
of reducing the number of outstanding shares if alternative uses
of capital are not as attractive, thus making each investor's
stake in the company bigger. When the corporate "pie" is cut
into fewer pieces, each share represents a greater percentage
ownership in the profits and assets of the business. Tragically,
many managements focus on domain building rather than increasing
the wealth of shareholders.
3. What are your reasons for investing in the
Before you purchase stock in a company, you need
to ask yourself why you are interested in investing in that
particular opportunity. It is dangerous to fall in love with a
corporation and buy it solely because you feel fondly for its
products or people - after all, the best company in the world is
a lousy investment if you pay too much for it.
Make sure the fundamentals of the company
(current price, profits, good management, etc.) are the only
reason you are investing. Anything else is based on your
emotions; this leads to speculation rather than intelligent
investing. You have to remove your feelings from the equation
and select your investments based on the cold, hard data. This
requires patience and the willingness to walk away from a
potential stock position if it does not appear to be fairly or
4. Are you willing to own the stock for the
next ten years?
If you aren't willing to buy shares in a company
and forget about them for the next ten years, you really have no
business owning those shares at all. The simple but painful
truth of this is evident on Wall Street every day. Professional
money managers attempt to beat the Dow Jones Industrial Average,
which is a collection of 30 largely unmanaged stocks. Year after
year, they fail to do this. It seems impossible that a portfolio
managed by the best minds in finance can't beat an unmanaged
portfolio of long-term stocks held indefinitely.
The guaranteed way to success has historically
been to select a great company, pay as little as possible for
the initial stake, begin a dollar cost averaging program,
reinvest the dividends and leave the position alone for several