If you’re buying a business — one that would represent your primary occupation — you’d probably do an FBI number on that business to find out all you can about it, before sinking any of your hard earned money into it, wouldn’t you?
That makes perfect sense. So why do people pay so much less attention to companies they’re investing money into, in the form of stocks and bonds?
Stocks and bonds are not merely pieces of paper, they represent a financial stake in a real business.
How you go about investing in those companies should not be much different than the way you would buy a business.
Invest in Businesses You Understand
If you are going into business, do you think your chances of success would be better if you put your money into a business you know a lot about? Or if you took a chance on one that is completely unknown to you?
The answer to this question is so obvious that even asking it is ridiculous, but few people consider it when it comes to investing in stocks and bonds.
In truth, you have no business investing your money in any company or industry where you have no knowledge at all. That’s a recipe for disaster, not a strategy for success.
Warren Buffett is a billionaire mega-investor, and one of the most successful who has ever lived.
He started his career in the insurance business, not as a professional investor, but actually working in the industry. When he decided to enter the investment world, guess which companies he chose to invest in?
That was the industry he worked in, and it was the business he knew. And it paid off in spectacular fashion. Buffett had early success by investing in insurance — where he continues to invest a large portion of his portfolio even now — then he parlayed that success into other businesses.
If you want to succeed in investing, you should follow his lead.
Great Products Don’t Necessarily Make for Great Investments
Some investors claim success comes from investing in the stock of companies whose products they like. It can be a simple way to choose investments because you are basing your decision on a tangible product, but that isn’t always a solid basis to make an investment decision.
While it is important that a company’s products and services are something customers would want to own or use, you have to be careful in using products as the basis for making a substantial investment in a company.
Many great products turn out to be fads. They hit the market with a vengeance, and seem to be the solution to everyone’s problem. But just as quickly, they end up on the trash heap of history along with cassette tapes and Kewpie dolls.
If you’re going to base an investment decision on a product, make sure it’s a product that cannot be easily duplicated by competitors, isn’t likely to experience early obsolescence, and generally has high per-unit profit margins, among other factors.
If You’re Wrong, You’ll Lose Your Investment
If you are buying a business for yourself, you’d certainly be concerned about the risk of losing your capital investment should the business fail. This should be no less of a consideration when buying the stocks and bonds of a large company.
Should the company fall on hard times — or fail completely — you can lose some, most, or even all of your investment. No matter what you’re investing your money in, you should never have a casual attitude toward the prospect of losing money in the process.
Money lost is capital that you will not have for future investments.
Think of it as Buying a Small Business
Before buying stocks or bonds in any company, pretend you are buying a small business for yourself. That will put you in the proper frame of mind to find truly good investments.
What information you would you be interested in if you are buying your own business?
- How long has the company been in business?
- How much do you know about the company’s specific business?
- What is the state of the company’s industry, and what are the future prospects?
- Who are their primary competitors, and how does the company stack up against them?
- What are their primary revenue sources, and are they reliable?
- What are the company’s future plans?
- Is the company facing any significant legal actions?
- Is the business facing any potential regulatory issues?
- Perform a detailed investigation of the company’s books — their balance sheet, profit and loss statement, subsidiary schedules and recent audit reports.
- Does the business have sufficient capital to run and expand operations?
Actually, this is only a sampling of the questions you should ask, and information you should seek if you’re looking to buy stocks or bonds in a company. If you are familiar with the business the company is involved in, you will have even more detailed questions.
And you should — after all, you’re buying a business, not a piece of paper.
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