The decision to invest in a stock is, by itself, a very elaborate process. For example, you need to consider the financials, the qualitative factors, the valuation factors, the sentimental factors etc. It would therefore always be useful to have a final checklist before actually placing the buy order for a stock. It could also be the other way round. You have decided to sell the stock and you may want to doubly confirm that you are on the right track. What are the questions that you must ask a company about their business to be doubly sure that you are on the right track? Is there a template for what to ask when investing in a start-up company or a new and innovative idea? Basically, what are the questions to ask a company before investing? More often, you may not be part of the company investor calls, so you can even post these questions to your analyst or advisor who gives you the idea. Here are 8 questions to pose before finally taking a buy or sell decision.
1. What are the key triggers for this stock and how close are they?
At the end of the day, even stock moves on triggers. A stock may be great fundamentally but unless the triggers are visible to investors and they are nearby then investment wait can be a long wait. For example, for the last many years Hindustan Unilever may have been a good stock. But the trigger came from the launch of GST and the big rural push. Similarly, in case of Reliance, the big push came from the launch of Jio despite years of outperformance in the refining and petchem business. Check for trigger visibility, first and foremost.
2. Are the triggers sustainable and are they time sensitive?
We buy or sell stocks to get our timing of the stock right. A stock may have triggers but the question is if the triggers are sustainable. For example, each year, in the past, the railway stocks would go up in expectation of the Rail Budget only to taper later. That is a case of unsustainable triggers for a stock. Also cyclical factors like monsoons, global cycles are not sustainable so don’t bet on them too much.
3. How good is the macro environment to buy or sell this stock?
However stock specific you are aware, the macro environment matters a lot. No point in buying a real estate stock when rates are going up or there is no point selling an NBFC stock when the rates are going down. One should not immediately be buying a paint company when global crude oil prices are going up. Always wait for an opportunity moment from a macroeconomic standpoint and also from the market standpoint.
4. Have you missed out on most of the rally?
Should you buy a stock after it has rallied more than 60% in a quarter. That is a difficult question to answer but always look for margin of safety. One of the basic rules in investing is that if something is too good to be true, then it is probably not true. If you think that it is worthwhile waiting a little longer to get the right price, then you may as well keep a bit of patience. Corrections give you better opportunities to buy.
5. Are the valuations stretched at this point of time?
This is a subjective question but important nevertheless. How do you decide on overpriced or underpriced? One way is to look at the valuations vis-à-vis the historic valuations. If the historic average P/E has been 28 and the stock is already at 30X P/E, then it pays to be a little cautious, unless there is a salivating growth story that you are missing out. Waiting a little has never harmed an investor.
6. Are you missing out something very obvious about the stock?
That is a tough call but there is a way to check this. Often, identify a good stock but it fails to attract buying interest in the market. You may be impressed with fundamentals but margins may be falling. There is obviously something that you have missed. It is time to do you channel checks. Talk to competition, talk to dealers and talk to analysts. Don’t commit your money to the stock unless you get clear answers.
7. Do you really understand what the company is doing?
It is easy to understand in depth about steel company or about shrimp exporter. They are a lot more tangible. But how do you measure or evaluate a company that is into areas like cloud storage, artificial intelligence, machine learning, genomics etc? These are still esoteric fields and quite often this leads to fancy valuations. Do you homework and ensure that you understand the revenue model and the revenue visibility before you commit your money to such stocks. Buffett never believed in technology stocks and waited more than 20 years before he invested in stocks like Apple.
8. Is the stock better than adding more of something you already own?
When you have investible funds you always have a choice to make. Should you add more to a stock that has been tried and tested or should opt for buying a new potential multi bagger? If you look at successful investors like Buffett, they have focused on a handful of stock which has been the mainstay of their portfolio for many years. That is specialization. You need to make this all important trade-off. Should you stick to your existing comfort zone or whether the new idea is really wroth the risk?