Investing in equity share is considered the most lucrative investment vehicle. Though investing in share is considered way more risky than other investment options, it remained at the top of the investor’s preference list due to the high return it offers in any given period compared to other investment options. An investor can purchase equity shares of a listed company from the stock market through his Trading account. A trading account can be opened with any stockbrokers by doing the required paperwork and payment of required fees.
There is no doubt that equity investment yields high-return but the investor must keep in his mind that the high return is always accompanied by high risk. Therefore, the prudent practice will be to exercise the necessary cares and take a cautious approach while selecting shares because all that glitters are not gold. Therefore, a well-crafted approach needs to be adopted by the investor in the stock picking task. It should be kept in mind that investing in the stock market is subject to the risk of market volatility and uncertainty, and no approach can cushion the investor completely from that risk. However, if an investor follows these five rules that we are going to discuss below he will be safeguarded to a reasonable extent. This five-point checklist for investing in share will help an investor to pick right share for investment.
Future prospects of the Industry in which the company operates
While an investor plans to invest in a company’s share for the long-term time frame, he must evaluate the future prospect of the industry in which the company thrives in. Future prospect of the industry determines the success and failures of a company playing in this sector. For example, the renewable energy sector has good future prospects. Therefore, investing in a good company having business operations in the renewable sector may turn out to be a profitable deal in long-term. On the other hand, the paper industry may see a downturn in near future due to global initiatives to go green. Therefore, investing in a company operating solely in the paper industry will be a bad decision.
The macroeconomic environment in which an industry thrives is like weather, if it becomes hostile and sluggish then no company in this industry can flourish and grow even though it is financially strong and sound.
Favorable financial ratios
An investor must do ratio analysis to find out whether key financial ratios are favorable. Financial ratios like Debt to equity ratio, Current ratio, Return on equity ratio, interest coverage ratio gives insight into the companies financial performance. Therefore, a debt-free company must be the choice. Other financial ratios like Dividend payout ratio and Divided yield helps the investor to determine the expected return on the investment.
A debt free or a low debt company performs financially better in a hard time than its highly leveraged counterparts. A highly leveraged company is quite similar to an overloaded ship. It may sink anytime if the weather turns grim.
Good profitability track record
A company which has maintained a steady profitability track record for at least five years is considered a good choice of investment. Sometimes, good companies record losses for one or two years due to unavoidable extraordinary events. The investor must factor the future implication of such events on the profitability of the company before deciding to leave it out of his wish list. In other words, if the downturn is temporary in nature and it will be resolved in short to medium term then such company may become a multi-bagger purchase due to its heavily discounted share price at the time of the difficulty.
A company having past records of making sound profit signifies that it understands its business and it is good at it. Therefore, it is safe to park hard earned money to grow it.
Performance of the board of directors
Board of directors is the manager of the company. They take the day to day business decisions on behalf of its shareholder, and the success of the company is heavily dependent on the competence, experience, integrity, and capabilities of the board of director. A well-governed company is generally a profitable company, and the good corporate governance comes directly from the board of directors. Therefore, before investing in any company’s share, an investor must look who is on the board of directors and what is their past performance record.
Competitors and competition
Competitors and competition are the two inseparable terms in the business. An investor must consider the level of competition in the industry in which the company operates. The market share of the company in its respective industry largely impacts its operating performance and profitability. Therefore, a perfect choice will be a company which has a substantial market share and proactive in fighting competition.
An investor must consider the above five factors while selecting a company for investment purpose. If you consider any additional point that should be included in the above list of “Five point checklist for investing in share” then please write in the comment section of this article. Thank You.