If you’re investing directly into a company, you need to take the time to think through its prospects.
It would be unwise to start stock-picking willy-nilly, but choosing some of your own investments directly is a great way to better understand the market.
If you’re new to the investment game, consider these questions – they can apply just as much to a blue-chip name on the New Zealand Stock Exchange (NZX) as they do to your brother-in-law’s new craft-brewing operation.
Where’s the business at now?
It’s important to understand the stage the business is currently at, and how big it’s wanting to grow. Is it already selling products and services, or is it still in the development stages?
If it is selling, how delighted are the customers? Are they recommending it to their friends?
Does it have a believable strategy for achieving that future growth? How will the company sell many times the number of products they’re selling now?
Is the sales cycle long or short, one-off or a repeat business? Is it a Volkswagen, producing more than six million cars per year, or is it a Tesla, still building up its production capability from 100,000 cars a year?
The further away a business is from reaching that future state, the bigger the risks are.
How important is a business model?
You want any business you own shares in to be profitable. This happens through a strong business model. Take Apple and its products.
Apple is the most profitable public company in the world, whereas the companies in China making the chips for the iPhone are just doing ‘okay’. Apple’s model allows it to make a lot of the money spent when consumers buy an iPhone.
Or consider the business model for a digital product, such as Spotify. Songs don’t need to be remade each time they are downloaded or streamed, so Spotify’s business model uses less resources.
This makes it much easier to grow the business, and makes it ‘scalable’, that is, easily able to scale up the size of its operations.
Trust in the people
When you’re buying shares in a company, you should view yourself as being an owner in that business – no matter how small your share is.
By extension, this means the managers are working for you. So, do you trust them to lead the company to success, and are there talented people around them to help them carry out that winning strategy?
It’s also good to know how much of a stake the managers have in their own company. Having a big stake in its success means a manager’s interest in its success is aligned with yours.
This is a real benefit of private companies, as the founders are typically shareholders and still involved in the day-to-day running of the business.
It doesn’t matter if you have the best product and sales team on the planet if you’re trying to sell steaks to vegetarians.
What puts a roof on how big a company can grow is the size of the market it’s selling to.
How much of that market the company captures depends on how good their competitors are.
If you get an idea of both the ‘blue-sky’ opportunities for the company and who they’re up against, it can help you see how likely it is to succeed.
Check the price
All the business prospects might look great so far, but the final thing to consider is the initial price you’re buying at. This decides what your eventual return might be.
Here are a few easy ways to decide how fair a price is.
Check what similar companies in the industry are priced at. See what professional shareholders and management are doing. Get your hands on as much research as you can.
Take this information with a grain of salt, because there’s no guarantee that other people have the same motivations or timeline for investing that you have.
Making direct investing decisions on your own can be tough, but it does give you the chance to potentially get satisfying rewards.
And if you don’t get it completely right on your first go, at least you’ve still had a learning experience to help you improve your investment game next time.
First published 5 June 2018
Story by Simeon Burnett
JUNO does not contain financial advice as defined by the Financial Advisers Act 2008. Consult a suitably qualified financial adviser before making investment decisions. This story reflects the views of the contributor only. Content comes from sources that JUNO considers accurate, but we do not guarantee that the content is accurate.