Tuesday 11 August 2015

3 Factors to Consider Before Investing in a Company

I'm going to share 3 of the factors that I consider before investing in a company in this blog post and why I use them. The factors are growth prospects, people and price. While there are some more industry specific ones such as profit margins for manufacturing firms, but I think that these three are the general factors that I consider before investing in a company.


(Image source: https://commons.wikimedia.org/wiki/File:Investing_money.jpg)


Growth Prospects

This can be the growth prospects due to growth in the industry the company is in and/or the company expanding within its industry. Some industries such as technology are more likely to grow in the future than others such as public transport due to their untapped potential. While some smaller companies that have superior technology to their larger counterparts that allows them to deliver more value to customers at lower costs are also able to displace them and become leaders of their industries.

This aspect is similar to growth investing as I hope to find companies that are able to grow their earnings greatly over time. While some industries are more likely to produce companies that will grow exponentially in the future, that doesn't mean that other industries do not provide companies with good growth prospects.

A focus on economic moats that can be easily scaled would be good in this aspect.

People

This refers both to management and the regular staff in areas such as marketing, R&D, etc. This is a much more subjective factor and is much harder to track unless you have the time to go down and see the company's operations for yourself. If not, most of the information that I can get on this aspect is usually from annual reports (that may paint a biased picture of the company).

I think a good guide to find good companies would be a focus on the customer and the long term, which can be seen through actions that affect short-term profits but build relationships and loyalty among customers.

The enthusiasm of the people in the company and the quality of the management (which includes factors such as honesty, willingness to expand) can be a good indication of the suitability of the company to expand. An unenthusiastic workforce, a dishonest management or a general unwillingness to adopt new technologies will make expansion of the company almost impossible and the growth prospects of the company is likely to be weak even in the most optimistic of industries.

Price

While the other two factors may be very good for the company, if the price is way too high, it is still possible for you to lose money on an investment. P/E, P/B ratios are some of the simple ways to relate the price to the quality of the share. Using Discounted Cash Flow and Dividend Discount Models are more complicated way but are able to take more factors into account.

A high price (in relation to earnings and book value) does not mean that the company is a poor investment, but if we are to invest in them, we have to be reasonably confident in their ability to grow their earnings. On the other hand, very low P/E ratios for a share may be a sign that the company's earnings are under threat or only temporary and would require a better understanding of the company.

Summary

I think the 3 above factors are important for us to consider before we decide to invest in a company. There are other metrics to go by, but I like to look for these 3 in companies that I pick out (not always able to find information on them available at all companies though).


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