If someone came to your door and told you a local business is for sale, would you buy it without hesitation? Probably not. You would first check out the business. Even if you have been a customer of the business, you would want to know more about the operation, how profitable it is, and a host of other questions. In short, you would do some research and ask the owner a ton of questions.
When it comes to investing in stocks, people don’t perform any due diligence. Many people can’t even be bothered to analyze the financial statements. They see a stock being pumped up on CNBC, and log into their online brokerage account. They specify a certain number of shares, and in an instant, they are partial business owners.
These same people often don’t view themselves as business owners. They view their recent transactions as a number, one they hope goes up in value. That is the extent of their involvement with their stock.
Some people will get deeper in their analysis. They may pay attention to earnings, or they will follow news stories as it relates to the stocks they purchased. Even fewer people will analyze the financial statements of a company. If you are lucky to find a person willing to do this, they probably go as far as creating ratios to see what kind of financial shape the company is in.
We seem to have lost sight of the fact that stock ownership is business ownership. When you pick up shares in a company, you are legitimately a part owner of that company. While you may not have enough shares to influence its day-to-day operations, you can and will participate in the profits. Conversely, losses will cause your stock to nosedive.
If you were considering that local business, what would be some of the questions you asked the owner? For starters, you would ask if he or she is profitable and how long it’s been that way? You would want to get access to the books of the business and see what kinds of transactions he or she recorded. Do you see any seasonal patterns? Are the profits sporadic or can you see a steady pattern of increases?
How about debt from the business? What kinds of loans are outstanding and has the business been able to effectively service those loans? Are the accounts receivables that are aging? How about accounts payables? Will creditors come knocking on the door the minute you take control of the keys?
What about the economic landscape in the area the business exists? Has the area fallen on hard times or is there an economic boom going on? You also want to get a feel for the competitors that may exist. How easy is it for others to start a similar business? Want kinds of price elasticity would occur if competition increases?
If people would treat their stock purchases the same as buying local businesses, they will have better reasons to be in certain stocks and stay clear of others. They would be able to tell you how the business operates and who the top management of the company are. They would be able to give you a synopsis of how that management team is doing. Most investors haven’t a clue who is running the companies of the stock they own. They would be hard pressed to tell you where the company is even located.
Corporate events would mean much more to those who took a vested interest. If you didn’t like the team running your company, suddenly, you can participate in voting them out. When is the last time you voted on a corporate proxy that was sent to you? Did you even know it was called that?
Have you ever been suspect of the price of a stock going up too fast, with no significant changes in the company? Most people would be ecstatic that the price of their stock has risen. They wouldn’t think twice to find reasons for this anomaly. There are plenty of reasons for the price of stocks to rise. Often, it can follow the price levels of the market itself.
Stock prices of certain companies can follow in the same direction as the industries they belong to. That too, is not unusual. In fact, you want this to be the case, most of the time. Ideally, you want your company to be the shining star of that industry, but it should do so in the context of what makes sense.
Why Don’t More People Become Intimate with the Stocks They Own?
The short answer is it takes a lot of work. Think about the scenario of buying that local business. There were many questions that you need to ask. Not only do you need to crunch the numbers, but you need to know what numbers to crunch and what the results signify. Most people aren’t trained on how to do any of this.
It’s no different with stock ownership. It’s simply easier to letting financial talking head dictate what stock to buy and follow the hype. This seldom leads to good choices. But, it is something we have grown accustomed to.
Let’s face it. Scouring through financial statements is about as exciting as watching paint dry. Actually, an edge should be given to paint drying because at least most people understand the significance of that activity.
Seriously, how many people have you heard say they couldn’t wait for the weekend so that put together liquidity ratios on stocks they own? It’s a rare find. Even if you had the inclination, do you know what the numbers tell you? Maybe you have an idea about one or two indicators. But, ten or twenty of them? Not happening!
There’s even more bad news. Investing is not the type of discipline that you can water down to make things easier on yourself. The factors you choose to ignore could be the ones that trip up your companies. There is no substitute for brute force analysis. You need to learn the ratios and what they mean for your company.
Take It Slow
Just because there could be dozens of fundamental factors doesn’t mean you have to learn them all in one day. The key to learning fundamental analysis is to get good at a few items. You may want to hold off on significant stock purchases until you get the majority down. That will take time, to be sure. But, having a solid grasp on each of the concepts, a little at a time, is going to take you far when you are finally ready to choose stock.
In the meantime, you should consider investing in mutual funds or Exchange Traded Funds (ETF). These are managed for you. While you still need to do some research on them, it is much easier to find rating services that can help. You may choose to stick with funds and abandon stock selection altogether. There is nothing wrong with that. Many people do significantly well with this approach and it frees up their time to do anything but stock analysis.
Invest in What You Understand
Do you know anything about Bitcoin? If the answer is no, then you have no business investing in companies where Bitcoin is the main focus of its business model. Warren Buffett kept away from Dot Com bubble stocks for the simple reason, he didn’t understand any of them. They made no sense to him. Their valuations made even less sense. He thought they were a fool’s game, and he was right.
Understand the businesses you are investing in. Don’t deviate from this rule. It’s okay to learn about new businesses and what they do. But, don’t invest until the business model makes sense to you and is something that will likely have a future.