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Investing
Things you need to know about a company
By Toni Case, February 18, 2008
 It’s not surprising that Apple Inc., the manufacturer of Apple laptops, iPods and related assessories, has been a bonanza stock pick. You didn’t have to be a gun stockpicker to see a connection between a worldwide craze for everything Apple-related and an upward trending share price. Apple Inc. shares have risen by more than 40% over the past year.
There’s an element of common sense to being a successful stock picker. During a resources boom or a tech boom, stocks associated with the booming sector usually perform well. Big miners Rio Tinto and BHP Billiton, as well as companies servicing the mining industry, have performed strongly over the past few years as the resources boom continues full pelt. When demand outpaces supply in an industry, it’s a fair assessment that prices – including the share price – will increase.
Successful stock picking involves a little more than just common sense, however. Although it is sensible practice to view a stock like you are buying the business – questioning such things as the quality of the products or services sold, the growth rate of the industry and its competitive position within it - there are other aspects to successful stock picking that you can’t spot easily, not unless you are an avid practitioner, or an analyst that spends days crunching the numbers.
So what sort of things should the novice investor look for in a company before buying its shares?
The accepted approach is to firstly stipulate the type of company that you wish to invest in. Retirees will be mostly attracted to companies that generate income in the form of dividends to help pay for living expenses in retirement. Younger investors, on the other hand, prefer stocks with the potential to soar up price charts, generating capital gains over time.
But irrespective of whether you’re seeking income or capital gains from your share investment, the company you invest in must, at the very least, survive over the long term. This is your hard-earned cash after all. You want to avoid losing it to failed companies like insurance disaster HIH or failed telcom OneTel. Typical warning signals of a company in trouble include such things as:
1. Profit downgrades and cuts to dividends
2. A falling market share for the company’s products and services
3. Unfavourable tax rulings or legislation that impedes a company’s income earning capability
4. Splits in the board of directors and frequent management reshuffles
It’s often said that if you don’t know what a company does then you shouldn’t own its shares. Indeed, it’s important that you are familiar with the industry the company operates in (for example telecommunications, media or building materials), the products or services it sells, its key trading partners and market positioning. Is it the market leader in selling bathroom fixtures, the country’s sixth biggest bank, or a small gold miner in Western Australia? You should know this before you buy.
Companies that dominate an industry are hard to beat. A company might hold the exclusive right to distribute a particular good or service, or hold a license that’s difficult to attain. A monopoly can widen margins and boost earnings, which, although not usually beneficial for consumers, is good news for shareholders.
It’s also worthwhile examining the barriers to entry into the industry or market in which the company operates. World famous investor Warren Buffett is a fan of buying shares in companies with high barriers to entry such as railway companies or credit rating agencies. "In business, I look for economic castles protected by unbreachable moats," Buffett states.
Clearly, if a cashed-up rival firm can easily enter the industry and successfully compete, it’s a riskier proposition than an industry that’s out of bounds to newcomers.
When buying a share it’s worthwhile investigating the management team. Who’s steering the ship? After all it’s the competency, determination and drive of management – and ultimately its CEO - that will determine the company’s future direction. Has the CEO held successful posts in the past in a similar industry?
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