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What you should know when buying shares

There are many factors to consider when buying shares. If you wish to go down the path of picking your own shares, the list gets even longer.  While it’s possible to get bogged down in the finer details of looking at charts and cash flow analyses, here’s a list of some of the core fundamental things you should look at.

What does the company actually do?

It’s important that you understand what the company does so you can make better judgments about investing into it.  Warren Buffet is often quoted as saying “never invest into something you don’t understand”. He’s probably onto something.

Is the company profitable?

Not all companies that are profitable are worth investing into, and not all companies that lose money are junk. However, it’s important to know which side of the ledger it sits on and why.  Are they burning through cash because they’re building something great, or because they have terrible management?

What is the company’s history like?

Does the company have a solid history of winning? Or do they continually make costly mistakes?  This says a lot about the management and culture of a company and will help you to understand if current management can steer the company to long-term prosperity.

What is the Price to Earnings Ratio?

The Price to Earnings Ratio is what the market is valuing the company at. It’s a simple but useful comparison between different companies within a sector. If it’s trading at a higher P/E to the industry average, ask why?  There could be a good reason, but if there isn’t, it’s possible it’s overpriced. Keep in mind that different industries tend to have different P/E.

Is the company sustainable?

Some companies have products that continue to sell well over the long-term, whereas others have products requiring constant revamping and that may not be relevant in the future. Blackberry is an example of a company that didn’t adapt their technology fast enough and eventually went from a high-flying tech company to a ‘has been’.

Does the company face new or fiercer competition?

Competition is great as it keeps a company on its toes.  Just look at Apple – they have to stay relevant by innovating and producing products that the market wants to maintain market share. However aggressive competition can lead to a price war, eroding margins and putting a company at risk. Remember the airline price war that took down Ansett?

What is the dividend payout ratio and is it sustainable?

Australians love dividends, especially in a low-interest rate environment. However, don’t just buy on the face value of the dividend. If a company is paying out most of its profit as a dividend, can it actually maintain it? If it drops its dividend, is it possible people who are after income rather than capital growth will sell down their shares? It’s important to look at the figures behind the dividend.

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