|
A wise investor needs to be prepared to do some up-front research. That’s especially true if you’re going to take a go-it-alone approach, but even if you rely on a professional financial consultant or a broker’s recommendation, it’s smart to conduct your own investigation, just to be on the safe side.
You might already have a favorite stock in mind. Maybe the company shares your philosophy about business or the environment, or they represent a well-respected brand. Or maybe you have no idea where to begin.
Today’s familiar brands don’t necessarily mean that their producers have long-term prospects. Until you dig beneath the surface, you really don’t know what you might find. But the more you know, the better your chances will be of making a wise choice, or avoiding a bad one.
Digging deeper is referred to as the “due diligence” process. That term simply refers to being diligent about investigating the claims that a company makes about their products and services, their management team, and the company’s financial performance.
To help you get started, here are a few “dos and don’ts” about due diligence. Let’s begin with the things you should do.
The Dos of Due Diligence Find out as much about a company as possible before buying its stock. That’s like kicking the tires, looking under the hood, and taking the company for a test drive.
For example, find out more about the business the company is involved in and evaluate its ability to compete in its industry. What is management’s past experience? If a start-up company specializes in electronics and you discover that the executive team has had years of experience designing footwear, it’s probably time to look elsewhere.
To learn more about a company, visit its website or write to them and ask for informative documents like the following: - • The Annual Report - You’ll find information including financial data, results of continuing operations, market segment information, and new product plans.
- • Financial Statements - Read the details about a company’s past performance, revenues and expenses and get a sense for its overall financial health.
- • The Prospectus - If the stock is an initial public offering (IPO) or is already publicly traded, the prospectus will reveal how investor money will be used, some background on the company, and an explanation of its cash flow system.
- • The 10K Filings - Companies that are already being publicly traded on the stock market must file various reports with the Securities and Exchange Commission (SEC). These SEC filings often contain a lot more detail about the company and its operations, such as executive compensation, the nature of liabilities outstanding, pending lawsuits and other disclosures about their financial condition that may not make it to the pages of the Annual Report (which you should consider a sales document that puts the company in the best possible light).
- • Conduct a Google Search - Enter the appropriate keywords at www.google.com and you can unearth a treasure trove of background information about any company you are considering investing in. The name of the company is a good start. But you can search for information about key executives, product brand names and competitive industry data as well. If the dollar amount involved is significant, some investors go a step further to retain the services of online “detective agencies” to ensure that there are no surprises looming.
Continued on next tab ... Go Straight to the Source As you read through these documents, start a list of questions. Call the company and speak to investor relations or anyone higher up the chain of command. It’s perfectly OK to make a pest of yourself. After all, it’s your money. Let them earn it.
Here are a few sample questions that might get you started. Pick the ones that make the most sense to you—but don’t overload yourself with so much information that you’re tempted to give up. - • How long has the current management team been together?
- • Has each member had prior experience in the industry? How much?
- • Has the management team conducted systematic market research?
- • What is the competitive advantage of the product?
- • Is the product or service unique and fully developed?
- • How large is the market and is it growing?
- • What is the composition and background of the Board of Directors?
- • Are minutes from past board and shareholder meetings available?
- • Can you see material information or documents furnished to shareholders and to directors during the last two years?
- • Who are the vendors and what are the risks associated with key suppliers?
- • Can the vendors be contacted?
Your Responsibility, Your Decision While the company’s management is responsible for disclosing this information and fulfilling the SEC’s regulatory requirements by filing annual reports, 10Ks and other financial documents, it’s the investor’s responsibility to check out the facts for accuracy and reliability.
By the time you’ve completed thorough due diligence, chances are you’ll have a reasonably good understanding about the company, the risks and the potential return on your investment. When you invest the extra effort in due diligence, you can invest in stocks with more confidence.
Key point: If you are working with a professional financial consultant or broker, they should be able to help you get answers to these questions. But be aware that they have neither the time nor the incentive to perform due diligence on your behalf. The reality is that they may be relying on “buy or sell” advice from analysts they trust. Remember, though, that it’s your money at risk, not theirs. Continued on next tab ... The Don’ts of Due Diligence Here are some examples of what not to do when deciding on an investment.
The water cooler tip
“It’s the hottest new stock ever – and you can still get in early.” Your well-meaning co-worker might be trying to do you a favor, but we all know that old adage about something that sounds too good to be true.
By the time a tip has become water cooler chatter, it’s already too late, whether or not the rumor is based on fact or fiction. It’s human nature to want to be on the inside track, but before you rush to place your order, ask the tipster a few questions:
1. How good are the company's revenues?
2. Do they have much debt load?
3. How many shares do they trade?
4. Who is on the management team?
5. What’s the competition look like?
When your friend stares back like a deer caught in the headlights, you can thank him and be grateful that you know enough to not take this kind of advice. The tip was probably not based on any actual research, but rather heard through the grapevine. It’s a little known fact that unscrupulous promoters who own shares of a particular stock, get the ball rolling with false tips hoping the price will spike so they can sell and take a profit.
Message Boards
The biggest sources of stock misinformation are online message boards. These forums are populated with trolls posting false and misleading information about stocks. If the hype that’s planted is alluring enough, the rumor mill does the rest. Don’t waste your time. There nothing of real value there, plus there is always the danger that some bit of information might stick but that you’d later forget where you heard it.
Email Spam
The most insidious online stock scams are the ones made to look like an inside tip intended as a private message to somebody else, but which accidentally ended up in your email box. It’s designed to be enticing, to make you feel as if you just got somebody else’s invitation to pick up a winning lottery ticket. Don’t be fooled, and don’t bother to reply to messages that arrive with subject lines like “Ready to Explode,” “Ride the Bull,” and “Fast Money.” The information is bogus and so is the return address.
Now please go back and reread the section on the Dos of Due Diligence because that’s the message we want to leave you with.
© 2008 Jose D. Roncal |
