10 important Company insights before investing in stocks:
Investing in stocks is not easy. Youngsters attract to the stock market by listening to the stories of huge profits. I have been investing in the stock market for quite some time. But mostly I focused on investment in individual companies after proper due diligence and thorough research about the company.
If you want to try your hand at stock picking, it’s important to understand all the company insights for investment decisions. You need to understand the value of the company both in the short and long term before deciding your investment in the company. Especially, when you are investing in stocks and holding it for a while, you need to keep an eye on the performance of the company.
Let us discuss what you need to understand about the company before investing in a company or stock.
Table of Contents
10 important Company insights before investing in stocks
Top-Down Approach
Before choosing or analyzing a company to invest in, you need to understand the approach that most of the mutual funds of big investors do. Usually, most of these investors take the top-down approach to identify a company stock to invest in.
In a top-down approach, you need to understand the performance of the global economy. How the major economies such as the USA, Europe, China, and other emerging countries are performing or are expected to perform. If you are investing in emerging countries such as India, Vietnam, etc. it is necessary to understand the global economic condition, Geo-political scenario, etc. to narrow down to the domestic economy.
Next to the global economy, the domestic economy is also a very important factor to understand before narrowing it down to sector and company to invest in. Read a lot about the performance of the domestic economy and political scenario. For example, if you are planning to invest in companies based in India, understand the Indian economy and political scenario. Both RBI and word bank are predicting an average of 7% GDP growth for the next two years. Hence, understand how the domestic economy is expected to perform over the next 5 years.
Understand the domestic economy and the sector
Before narrowing down to a company to invest in, choose a specific sector that is expected to perform well in the next 5 years or so. For example, the manufacturing sector in India is expected to boom as the government is focusing on making in India. Similarly, the chemical sector in India is also expected to perform well driven by the China plus factor.
The easiest way to gain knowledge about the above factors is to read or listen to the news regularly. A lot of websites are available that give information about global as well as domestic news. Put a reading habit and note down the important points to relate it with the company at a later stage.
Understand the Company Business
Understanding or analyzing a company to invest in is not that difficult. There are many websites, blogs, broker houses, and news channels that provide a lot of information about the company. However, one channel or blog does not provide all the required information. You need to search for the best site that you can trust and find all the relevant and required information about the company insights with an example before investing. You can get a lot of first-hand information about the company from its annual report and other company presentations.
The most important insight about the company to invest in would be its business model. Simply, what does the company do as its business does or how it makes money? Is it manufactures products or provides services? Which sector does the company belong to? Does the products or services valuable to the consumers? Does the company have its brand name? Are there any better alternatives available in the market or who are its competitors?
All the above questions need to be answered to understand the business of the company. The product or services of the company must be sustainable for the long term. Many fake companies are floating over as penny stocks. You need to be very careful while choosing a company to invest in.
For example, Lumaxtech, is the company to invest in. This company belongs to the auto component industry. As a top-down approach, we understood the domestic economy is expected to do well. The demand for the automotive industry will also pick up in the election year. Particularly government’s push toward electric vehicles will boost the demand for the auto component market. Now, Lumaxtech manufactures two-wheelers as well four-wheelers. Domestically, Maruti, Honda, Mahindra, Tata, TOYOTA, FIAT, SKODA, etc. are among the major customers of the company. Hence, this may be a good company to invest in for the medium to long term.
Apart from understanding the business model, one also needs to learn other financial parameters and management.
Understanding Competitor Advantage or Moat
All businesses serve a particular industry and within that industry, the company competes with each other. Few companies have their Moat. Moat refers to the ability of the company to maintain competitive advantages over a long time. This moat helps the company to have superior relative strength over its competitors and helps to maintain profitability in the future. If a company has an edge over its competition, it is a promising sign for future growth. This is a more important factor in finding a good company to invest in.
Competency of Management
Competent Management is very crucial for Business Success. Many times, competent management turns the business up from a bankrupt situation. Hence, it is important to understand the background of the management in terms of their education, skill, and experience in the industry.
Competency management is the key skill necessary for an employee to get the desired result in their specific role. Developing and optimizing those skills to utilize for the improvement of the business strategy of an organization.
Highly skilled and experienced management drives the business of the company. Understand the strategy of the management like if the company is more into acquisitions or innovative product launches etc. How well the management communicates with its stakeholders. That will help you understand the management and its future growth plan. Always do a historical background check for all these factors.
Earnings Growth of the Company
Financial analysis for investors is most important for a company to invest in. Learn more about the revenue of the company. Understand the revenue growth over the year. Components of the revenue and its geographical distribution. Explore the trend of the income if it is increasing. If a company has steady and consistent earnings growth over time can be a good bet for the future.
Business Stability in the Industry
Business stability is one of the important factors to understand before investing in a company. You need to understand the addressable market of its products in the future. Look at the expected performance of the industry that the company belongs to. Consider the Industry as a whole and the company’s market share within that industry.
Explore its balance sheet. Read company annual reports and presentations. Can the balance sheet withstand a severe economic downturn? Suppose a severe recession starts tomorrow, does the company has the financial capacity to survive this or it will go bankrupt?
Every company has to go through a business cycle and that is natural. If the company has enough cash flow and the business is spread across the geography, it can easily withstand the economic downturn and will give good returns over the long term.
Debt-to-Equity Ratio
Borrowing is an important factor to understand a company’s financial performance. If the company has large debt maturities, then a major portion of the cash flow goes into interest paying. The company will not be able to pay back to its shareholders. If the debt-equity ratio is well below 1% it is good. Lowering the debt-equity ratio is better for the company to invest in.
All companies, big or small, carry debt on the balance sheet. However, a high amount of debt is a problem for the company, specifically, during the high-interest rate period. Read the company’s annual report and compare the debt-to-equity ratio with its competitors.
Price-to-Earnings Ratio
Now coming to the micro level, Price-to-earning or PE ratio is one of the important parameters to understand stock performance. This ratio helps the investor to understand the market value of the stock based on its future earnings. This ratio says how much you are paying for the stock today while estimating its future earnings.
Simply, the PE ratio is a division of the current share price and EPS (Earning per share). If the PE is higher the stock price is relatively overvalued. A stock of a company is better with a lower PE ratio relative to its sector PE and that of its competitor.
However, do not rely on this factor alone. While it helps compare a company to others in the same industry, it is always better to understand other parameters along with PE before investing in a stock.
Dividends Pay-out
If a company pays regular dividends, it is considered a stable company with strong cash flow. However, if a company pays very high dividends, that may reflect that the company does not have a future expansion plan. Often, new or emerging companies do not pay dividends as they want to reinvest the cash flow into business expansion. If you are investing in stocks for dividends as a passive income then consider companies with higher dividends. Else, look for companies that pay modest but regular dividends over time for a stable income from both stock price appreciation and dividend income.
These are 10 company insights for investment that you need to understand before investing in a stock. These are not all but the most important parameters to understand before choosing the company or the stock. You also need to look for other parameters from balance sheet to understand company insights for investment decisions.
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