Finding the right companies to invest in can be a long and time-consuming process. Even if you use some kind of stock screening tool, you may still be left with a shortlist of 100 or more different companies. However when you have eventually narrowed this list down to a more manageable number, there are two key questions you should ask yourself to help you decide which company to invest in.
The first question is simply this:
– Assuming money is no object and you were preparing to actually take over the company (with the asking price being the current market capitalisation), would this company be a good investment?
In other words are the net profits sufficient enough to justify paying the full market capitalisation of the company? This basic valuation method is used by the successful British investor, Robbie Burns, and is very effective. The general guide that Robbie uses is that a company is generally only worth investing in if it’s market capitalisation figure is less than 15 times net profits. In today’s markets, however, you would probably be better off lowering this figure to around 10 because the stock markets are very depressed at the moment.
The second question you should ask yourself is this:
– Are you prepared to hold onto shares in this company for the very long term, for example, 5, 10 or even 20 years?
If you cannot answer yes to this question then it obviously means that you question it’s long-term future and are worried about it’s long-term growth prospects, so you should therefore remove it from your shortlist, unless it’s nothing more than a short-term trading play.
The best companies to invest in are huge market-leading companies who continue to stay ahead of the competition. As a result they continue to deliver shareholder value because their overall profits, as well as their dividends, continue to go up every single year. The same cannot be said about young start-up companies, or indeed lots of medium-sized companies, which is why they carry so much more risk.
Overall though, if you can answer yes to both of these questions, then you should hopefully make some solid investments, particularly if you time your purchases and only buy shares when the wider markets are trading at very low levels. Even the very best companies fall with the wider market, so heavy stock market falls can present you with some excellent buying opportunities.
Article Source: Articles Engine