3 Important Questions to Ask Before Investing in Any Stock

I get so many queries about so many stocks for investment and I can reject most of the stock investments in minutes and the reason being I testify them based on these 3 important questions about business for investment.

This 3 questions are my first line of rejection for any business and it is not based on sales, EPS or any other number that is part of the balance sheet.

Nor these questions are about companies management, their operations or their efficiency.

On top of it, these are not about the charts. Actually these questions are not even about the price of the stock either.

So what are those questions?

Let me share with you questions that I use to reject any business for investment very easily.

Is the business unique or there is price competition that can impact margin and profitability of the business?

This is first and the foremost question that I ask before investing in any business and this helps me reject most of the business that are yet another or me too kind of business.

Yes when you have a business where you can have other players but if you have them, can you invest in the market leader in the segment because they will have much better advantage of pricing their product or services than smaller players.

If you are getting into the price competitive business, make sure you choose the player who is low producer of the product and has the best operating margin for the product.

Ideally when you are looking for a unique business, there are many sectors that become an avoid like metal, sugar, cement, telecom, aviation.

You will not see my investment in these sectors with an exception of Tata Steel. The main reason for Tata Steel was for sale of their UK plant which was a unique selling point of the business at that time when I invested and when that got into trouble, I was out of the stock in a flash.

Is the market big enough for sustainable growth of business for an elongated period of time?

There are many companies that have outgrown the sector as a whole and are now stalled for growth. Classic examples are Reliance Industries and Bharti Airtel. They have outgrown the sector they operate in and are not able to find growth by expanding their world view of business.

There can be many ways to increase the world view of business including moving to a new location (Bharti Airtel tried moving to Africa and that was quite sometime back and then nothing much after that and compare that to Vodafone which expanded their business in India and is moving to other geo), coming up with new product lines, mergers, acquisition, business synergies, investments, buying growth etc.

Every market leader will hit such roadblocks at one point of time or other. L&T, TCS, Hero Moto Corp, Maruti, Page Industries, MRF Tyres and the list of such stock can be endless. Company should invest in R&D or looking for acquisition will be in a better position to handle such roadblocks.

Never invest in any business where market leaders have outgrown the sector they operate in and have no more room for growth. Mid cap or small cap players in those sectors is also an avoid because it may be tough for them to compete with big players and even if they do, they can have similar issues of finding growth in the future.

Is business simple enough for the common investor like me to understand?

I am not from a financial background and I admit there are certain things that I don’t understand when evaluating a business and I try to learn as I move along.

I am not able to understand the concept of a listed group of companies. A group of companies is a company formed to invest in many of their own businesses.

JayPee associate is a classic example where I could not understand why a company be listed that has no business and invest in other companies like Jaypee Cements, Jaypee hospitals …. List those businesses as companies where you need money for growth and it can have much more transparency for investors in results. When a group of company share results, investors are not sure which of the business is making what kind of revenue for the parent company.

So any company that holds many other companies is an avoid. I prefer investing in such business individually or if I want to invest in many companies with one investment use a mutual fund.

A point to note here is if a company was operating in a business and expanded to other business and may have more than one business now under the same company is completely different and is not a group of company.

Over to you

What are your criteria to avoid investing in a company? Share them in comments below.