20 Questions You Should Ask Before Investing In Stock (2024)

Do you have a great investment idea? Or maybe your friend just told you about this amazing opportunity to invest in a stock early? Before getting into the game, here are my 20 Questions You should ask before investing in stock.

I’m personally using this framework to evaluate my own stock market investments. Since I’m a long-term investor, my framework is geared towards this investment strategy.

Need a simpler framework? Look at my article How to Research Stocks: 8 Steps for Beginner Investors.

In a study in 2021, Charles Schwab surveyed 1000 people about their investment behaviors. They found that between 2020 and 2021, long-term investments gained a lot of momentum. The percentage of investors citing a long-term investment strategy grew from 56% to 72%. More individual investors embrace long-term investing, which I absolutely love to see!

What Does It Take To Be A Long-Time Stock Investor?

To be a successful investor in individual stocks, you must equip yourself with the right tools. There are a lot of different approaches out there, and quite frankly, some of them are very hard to understand and grasp! But there is one thing they all share: It requires hard work and research to ensure your long-term success and good investment decisions. You need to keep a close eye on your investments.

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Since you are a long time stock investor, you already have a higher risk tolerance than most investors. Otherwise you would just invest into mutual funds, index funds or Exchange-Traded Funds. But that doesn’t mean that you should just let your investments run. After all, you are taking a higher risk to eventually enjoy higher returns, right? So it is a good idea to have your own research framework that asks the right questions.

After all, investment can be as complex as you would like. But it can also be very simple.

Related Post: Different Types Of Investors In The Stock Market

I created this framework of 20 key questions for investors with a long investment horizon. It takes out the guesswork and reveals facts about how well a business performs.

The Basic Premise Of The Framework

Well-run companies are best positioned to succeed in the long term. If a company has an excellent management team, a good working culture, stellar financials, R&D investments, etc., it has laid the groundwork for success.

A framework geared towards finding such companies will increase your odds of success. This is the premise of this framework.

Dividing The Framework In 5 Categories

1. Leadership Team – A company’s leadership team plays a crucial role in shaping its strategy, performance, and culture.
2. Management Team – A company’s Management Team is a very important category when gauging your investment’s long-term viability. They play a vital role in the success of the company in various ways:
3. Business Insights – Business insights like profitability, research and development (R&D) investments, financial runway, customer diversification, and return on equity (ROE) are crucial in understanding a company’s financial health, operational efficiency, and future potential.
4. Financials – Financial indicators such as revenue growth, stable cash flow from operations, free cash flow, cash-to-debt ratio, debt-to-EBITDA ratio, and the Altman Z-Score are important because they provide insight into a company’s financial health, operational efficiency, and overall financial risk.
5. Stock Metrics – Stock metrics such as dividends, price-to-earnings ratio, stock volatility, and short sellers play critical roles in assessing a company’s value, financial health, and market sentiment towards it. Understanding these metrics can aid investors in making informed decisions. Each of these metrics offers a different perspective on a company’s financial health, valuation, and the market’s perception of its future prospects. Together, they can provide a more comprehensive view of the company’s investment potential.

Each category provides several questions you should ask before investing in stock.

Related Post: When Is My Investment Portfolio Diverse Enough

#1 Does The CEO Have A High Glassdoor Approval Rating?

CEO Approval ratings show how satisfied employees are with their CEO Leadership Style. Since happy employees are the key to success, the approval rating is extremely important!

Glassdoor provides a platform for employees and former employees to talk about their experiences at the company. You can read about the workplace, benefits, and leadership.

CEO approval ratings naturally differ by industry:

#2 What Is The Glassdoor Rating From Employees?

Employee sentiment is a measurement to determine the happiness of the employees. Many factors influence the happiness of employees.

If you are a happy employee, you drive your company’s success. You are productive and have less stress.

Being happy is also contagious. If you work with a happy co-worker, you are likely happy too.

The average company rating on Glassdoor is 3.7 out of 5 stars across all companies. If you take some time and read some reviews about the company you are interested in, it can give you very valuable and additional insights. After all, the (former) employees know much more about the internal business structure than you will ever know. Having a bad rating on sites like Glassdoor can greatly impact the company’s ability to hire new workers.

Make sure to read the good and the bad reviews.

#3 Does The Company Have A Moat?

Understanding whether a company possesses a significant “moat,” or barrier to entry for potential competitors, is crucial for long-term investors for several reasons:

1. Competitive Advantage: A company with a substantial moat is likelier to maintain a competitive advantage. Suppose new competitors face significant economic, technological, or regulatory hurdles to enter the market. In that case, the existing company is expected to retain its customer base and market share, boosting its long-term profitability and stability.
2. Sustainable Profits: High barriers to entry protect a company’s earnings. When it’s difficult for new companies to enter the market, existing firms can generate profits over a more extended period, which benefits long-term investors.
3. Pricing Power: Companies with a significant moat can often control their pricing better. Since customers can’t easily switch to a competitor due to the high barriers to entry, the company can maintain or even increase prices without losing significant market share.
4. Return on Investment: A company with a strong moat is likelier to deliver a consistent return on investment. These businesses are often more resilient during economic downturns, and their stocks can provide long-term value growth and stability.
5. Innovation: Companies with technological barriers to entry often operate in a high-innovation environment. This can lead to further product development and improvement, creating more value for the company and its investors.
6. Network Effect: A network effect is a powerful form of economic moat that occurs when a company’s product or service becomes more valuable as more people use it. This creates a virtuous cycle leading to significant market dominance and profitability.

How to Research A Moat?

The research for the moat can be challenging. I recommend checking on craft.co for the competition. Suppose a competitive company looks equally or more impactful and is public; research it thoroughly and decide if this company or the competitive company has an outsized advantage. If you found out the advantage, you found the moat.

If the company has only a cost or size advantage, the moat is pretty narrow, so keep your eyes on the competition. High switching Costs and intangibles are hard to beat and seen as a wide moat.

#4 Is The Company Free Of Direct Competitors With Substantially Greater Resources?

This question you should ask before investing in stock is crucial for long-term investors because it helps identify whether the company has a competitive advantage and is positioned to maintain its profitability and growth. If a company’s direct competitors have substantially more resources, they could outcompete it in various ways.

Ways Of Competitive Advantages

• Price Competitiveness: More resource-rich competitors might be able to undercut prices, driving customers away from the smaller company. They may also be able to absorb short-term losses in a price war.
• Market Reach and Brand Awareness: Larger competitors often have more resources to spend on marketing and advertising, potentially drowning out the smaller company’s efforts and making it harder for them to attract and retain customers.
• Innovation and Product Development: Larger competitors usually have bigger budgets for research and development. They may be able to innovate more rapidly, continually staying ahead in the product offering.
• Bargaining Power with Suppliers: Bigger competitors may get better terms with suppliers due to larger order volumes, which can lower their costs and increase their competitiveness.

#5 Does The Company Have Customer Concentration?

This question you should ask before investing in stock seeks to understand the spread and diversity of the company’s customer base. It examines whether the company’s revenues are broadly distributed across numerous customers or concentrated in a few large clients.

In the US, companies must report any customer concentration above 10% to the SEC (Securities and Exchange Commission).

Related Post: Company Filings: A Must-Read Guide for Investors

Your best bet is to look inside the company’s quarterly filings, 10-Q. Go to sec.gov and search for the company. Open the file and look for keywords like “customer” or “client.” Sometimes, you might not find any information, and that is ok. Since companies are not required to add information about it without concentration, many don’t even mention it.

Unfortunately, researching this critical fact is more challenging, but knowing customer concentration is essential.

#6 Has The Company Been Consistently Profitable In The Past Quarter And The Past 12 Months?

This question you should ask before investing in stock is significant for long-term investors as it helps assess a company’s financial health and operational efficiency. By not just checking the last quarter, you ensure that the profitability was not just a one-time event or an anomaly.

1. Profitability Indicator – A company that has consistently reported profits in recent quarters is typically seen as a financially healthy business. It indicates that the company’s operations generate more income than expenses, which is a positive sign for any investor.
2. Sustainability – Regular profitability over an extended period (such as the past 12 months) indicates a degree of sustainability in the company’s business model. It suggests that the company can maintain its operations and generate profits under prevailing market conditions.
3. Risk Assessment – Profitable companies have much fewer financial reasons to worry about. They can focus their energy on the business and innovation.
4. Potential for Dividends – Profitable companies are likelier to distribute dividends to their shareholders. This can be an attractive feature for long-term investors, particularly those looking for income-generating investments.

#7 Have Research And Development Investments Trended Upwards In The Past Year?

Investments made in R&D ensure that a company can keep a competitive edge. Increasing R&D investments demonstrate a commitment to innovation, product development, and future growth opportunities.

Why Is R&D Investment Crucial?

Innovation and Competitive Advantage – Companies that continually invest in R&D will likely stay at the forefront of innovation in their industry. This is especially critical in rapidly evolving sectors, such as technology, pharmaceuticals, and automotive. A company can maintain or develop a competitive advantage by keeping up with or advancing beyond the state of the art.

Future Growth Potential – When companies invest today, they are really investing in tomorrow’s growth. These investments ensure the company gets or maintains a leadership position.

Adaptability – A company’s willingness to invest in R&D also shows its readiness to adapt to changing market conditions. Such adaptability is usually a positive sign for long-term investors, as it suggests the company can survive and thrive amidst changes in its operating environment.

Financial Health – On the flip side, if a company is increasing its R&D spend, it suggests it has the financial health to do so. This could be a positive sign of the company’s overall financial condition.

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Long-term Focus – Finally, R&D investments often pay off over the long term. Therefore, increasing R&D expenditure could indicate a management team focused on long-term value creation, aligning with the mindset of long-term investors.

#8 Does The Company Need Additional Funding In The Next Three Years?

Companies that don’t have enough cash are sometimes required to raise fresh capital to increase their financial runway. A company might have to pay higher interest rates or agree to generally unfavorable conditions in such circ*mstances. This can result in even more pressure on the business.

Important Note

The need for external funding isn’t always a negative. It can also indicate opportunities for expansion, acquisition, or other growth strategies that could produce high returns. It’s, therefore, important to consider the broader context of the company’s overall strategy and growth potential.

#9 Does The Company Demonstrate A Return On Equity Of 15% Or Higher?

Return on equity (ROE) is a critical financial metric that measures a corporation’s profitability in relation to the equity owned by its shareholders. It is calculated by simply dividing net income by shareholders’ equity:

What Does ROE Tell Me?

1. Efficiency of Management – A higher ROE implies that the company’s management uses the shareholders’ capital efficiently and generates more profits per dollar of equity. It shows the ability of the management to generate profit from resources provided by shareholders.
2. Profitability – A higher ROE generally indicates a more profitable company, which can lead to higher stock prices and potential dividends. It strongly indicates a company’s financial health and future growth prospects.
3. Comparison – ROE can be used to compare the profitability of companies in the same industry. A company with an ROE higher than its competitors or the industry average might be a better investment.
4. Sustainability of Growth – Companies with high ROE are usually able to sustain their growth without requiring as much debt. Investors typically prefer companies that require less debt to finance their operations, as it reduces risk.

A high ROE indicates that the company effectively utilizes shareholder equity to generate profits. It suggests strong management and efficient capital allocation.

#10 Has Revenue Been Growing?

Revenue growth is a primary indicator of a company’s financial health. This is an important question to ask before investing in stock.

An increasing revenue trend indicates that a company is selling more products or services, potentially gaining market share and effectively responding to market demand.

Sustained revenue growth often suggests successful business strategies and the company’s ability to expand into new markets or customer segments.

Revenue growth is closely tied to profitability. While revenue does not directly translate to profit, a company with increasing revenues has more potential to achieve and increase profitability, assuming it manages costs effectively.

#11 Is Operating Cash Flow Greater Than Net Income?

Net income is the profit a company reports on its income statement. However, accounting rules can influence this number, such as recognizing revenue before cash is actually received or spreading out costs over several years. So, a company might report a profit even if it doesn’t have much money.

On the other hand, operating cash flow looks at the actual cash coming in and going out from the company’s main business activities. It’s a more direct measure of whether the company is generating cash.

If a company’s operating cash flow is consistently higher than its net income, it’s a good sign. It means the company is bringing in more cash than it’s reporting as profit. This shows the company has a solid cash flow from its business and isn’t just relying on accounting methods to show a profit.

In other words, this question helps investors see if the company’s reported profits are reflected in its cash flow, which can give them more confidence in its financial health and future prospects.

#12 Is The Company Producing Free Cash Flow?

Free Cash Flow (FCF) is the money left over after a company pays for its expenses, like salaries, rent, supplies, and anything it bought to grow the business (like new equipment or buildings).

This metric is important for multiple reasons:

1. Check Company’s Health – If a company has money left over (positive FCF), it means it’s doing well, earning more than it’s spending.
2. Investing in Growth – A company with lots of leftover money can use it to grow the business more, like developing new products or expanding into new places.
3. Genuine Profit – FCF is a better way to see if a company is really making a profit since it’s harder to fake with accounting tricks.
4. Rewards for Shareholders – If a company has lots of leftover money, it can share this with the owners (shareholders) by giving them some of it as dividends or buying back shares to increase the stock price.
5. Paying Off Debts – If a company has debts, having extra money can help it pay off those debts and be more financially stable.

#13 Does The Company Have More Cash Than Debt?

The cash-to-debt ratio is a financial metric that you can use to evaluate a company’s financial strength. It measures how much total cash and cash equivalents a company has in comparison to its total debt. This ratio can give you a sense of a company’s ability to cover its debt.

Reasons why this metric is important include:

1. Liquidity – A higher ratio suggests that the company has more liquidity, or cash on hand, to pay off its debt obligations as they come due.
2. Financial Flexibility – Companies with a higher cash-to-debt ratio generally have more financial flexibility. They can use their cash reserves to invest in new projects, expand operations, or deal with unexpected costs or downturns.
3. Risk Assessment – A company with a higher cash-to-debt ratio may be considered less risky from an investor’s perspective. The company is more likely to pay its debt even with financial difficulties.
4. Debt Management – A higher cash-to-debt ratio may indicate that a company has successfully managed its debt and maintained a strong cash position.

#14 Does The Company Have An Altman Z-Score Greater Than 3?

This is my favorite question you should ask before investing in stock.

The Altman Z-score is a statistic created by finance professor Edward I. Altman in the 1960s that is used to predict the chances of a business going bankrupt within the next two years. The score is a linear combination of five financial ratios derived from a company’s financial statements.

A score above 3 suggests a lower likelihood of bankruptcy, hence its importance for long-term investors.

What Does The Altman-Z-Score Tell You?

• Early Warning Signal – The Altman Z-score can often forecast financial distress several quarters before it occurs, giving investors a potential early warning signal. This allows them to reassess their investment or take corrective measures.
• Benchmarking – The Altman-Z-score can also be used for benchmarking purposes. To evaluate relative financial strength, you can compare a company’s Z-score with those of other companies in the same industry or sector.
• Risk of Bankruptcy – The score is designed to forecast the probability of a company entering bankruptcy within the next two years. A score above 3 indicates that the company is less likely to declare bankruptcy, implying that the investment is less risky.

#15 Does The Company Have A Net Debt-To-EBITDA Ratio Under 2?

This question you should ask before investing in stock is essential for long-term investors because it gives insight into the company’s leverage position and its ability to pay off its debt.

• Debt Repayment – This ratio indicates how many years it would take for a company to pay back its debt if net debt and EBITDA remain constant. A lower ratio means it can pay off its debt quicker, which is generally more attractive to investors.
• Financial Health – If the net debt to EBITDA ratio is less than 2, the company has a strong earnings base relative to its debt level. This is generally a sign of good financial health and effective debt management.
• Interest Rates – A company with a low net debt to EBITDA ratio is less exposed to interest rate risk. A highly indebted company could face significantly higher interest expenses if interest rates rise.
• Flexibility – A company with a lower ratio generally has more financial flexibility and is better positioned to invest in growth opportunities, pay dividends, or withstand economic downturns.

A low net debt to EBITDA ratio indicates manageable debt levels and the ability to generate sufficient earnings to cover debt obligations.

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It’s also worth noting that some industries, like utilities and telecoms, naturally have higher ratios due to the capital-intensive nature of their operations.

#16 Is The Company A Large-Cap Company Of At Least $20 Billion?

Companies with a large market capitalization are generally considered to produce more reliable or predictable growth. Small companies tend to have more competitors. Thus, their business model is more often than not considerably challenged. They are also more vulnerable to financial distress and generally more volatile.

Market Cap Ranges

Companies are grouped into ranges in terms of their market capitalization.

#17 Does The Company Pay A Dividend?

Dividends are like a bonus that the company gives you for owning their shares. It’s extra money in your pocket. If a company pays dividends, it’s usually a good sign. It means the company is making money and is healthy enough to share it with the shareholders.

Make sure the company does not take on debt to pay a dividend. That can be a sign of weakness.

But not all good companies pay dividends. Some prefer to use their profits to grow their business, pay off debts, or fund new projects.

Dividend payments can provide a consistent income stream and indicate a company’s financial strength and shareholder-friendly approach.

#18 Is The Stock Trading For A Positive Price-To-Earnings Multiple Less Than 30?

As long as you know the company you are looking at, the P/E ratio as a metric is very useful for you as an investor.

Every company, throughout its lifetime, will go through various stages, illustrated by the table below. In every single stage, the P/E ratio should be interpreted differently and can also tell you different things. If you want to use this metric effectively, you need to know at which stage a company is.

#19 Is This Stock Relatively Free Of Volatility, With A Beta Under 1.3?

Beta measures how much the price of a stock moves compared to the whole market. A beta less than 1 means the stock doesn’t move as much as the market. This makes the stock’s price more stable, which is good because you have fewer surprises.

I have chosen a value of 1.3 because I’m not too concerned about a stock being a bit more volatile than the market. Less movement (or volatility) usually means less risk. A stock with a low beta is less likely to have significant price drops.

#20 Are Short-Sellers Generally Staying Away From This Stock?

Short-sellers are investors who bet a company’s stock price will decrease. They borrow and sell shares of the stock, hoping to repurchase them later at a lower price, return the borrowed shares, and pocket the difference.

So, if many short-sellers are targeting a particular stock, it can be a sign that they believe the company is facing challenges that could cause its stock price to fall. High levels of short interest can be a red flag for long-term investors.

That being said, high short interest isn’t always a bad thing. Sometimes, short-sellers get it wrong, and a high amount of short interest can lead to a “short squeeze.” That’s when short-sellers are forced to buy back the stock to cover their positions, driving the price up rapidly.

Short reports can be useful for long-term investors because they often highlight potential risks or challenges facing a company that may not be apparent from the financials alone. Short-sellers usually do a lot of research before shortening a stock, and their findings can offer valuable insights.

Final Thoughts – 20 Questions You Should Ask Before Investing In Stock

Phew, that was a lot to take in. These questions you should ask before investing in stock are all important from my perspective. They will give you a deep understanding of the company you want to invest in. After all, you are in for the long haul. The time you invest doing your own research is well invested time and the best way you can increase the odds of success..

Besides these 20 questions you should ask before investing in stock, you can do research in many other ways. One example is to use a discounted cash flow model. The more data points you can gather and track, the better.

Remember that almost no company will have the perfect answer to these questions. That will not automatically mean it isn’t a good investment. Do your research and come to your own conclusion.

When investing in company stocks, it is not only your initial research that is important. Every time a company has quarterly earnings, you can review the new information to revalidate your investment thesis.

Disclaimer:The information in this blog post should not be considered investment advice or a replacement. They are solely provided for informational purposes. Please consult with a financial advisor before making any investments. Past performance is not a good indicator of future returns. Also, none of the mentioned stocks are to be understood as recommendations. Don’t buy yourself something solely based on what you read here.