Investing in stocks can be a rewarding way to grow your wealth and achieve your financial goals. However, it can also be a risky endeavor if you don’t do your homework beforehand. Buying a stock without proper research is like gambling with your hard-earned money. You may get lucky and win big, or you may lose everything.
That’s why it’s crucial to ask the right questions before buying any stock. Knowing the answers will help you make informed and confident investment decisions. It will also help you avoid costly mistakes and pitfalls that many novice investors fall into.
In this article, we will share with you 10 important questions that every investor should ask before buying a stock. These questions will help you evaluate the company’s business, financials, growth, valuation, risks, and more. By answering these questions, you will be able to determine if the stock is worth buying or not.
Let’s get started.
1. What does the company do and what are its key products or services?
The first question you should ask before buying a stock is what the company does and what are its key products/services. This will help you understand the company’s business model, its target market, and its competitive position. You should be able to explain in simple terms what the company does and how it makes money. You should also be familiar with the company’s main products/services and how they differ from those of its competitors.
For example, Apple designs, manufactures, and sells consumer electronics like the iPhone. Its main offerings are key to revenue and profitability. Microsoft develops and licenses software like Windows and Office. These flagship products dominate the business.
Research the areas where the company operates. What is its competitive positioning in those markets? A well-defined business with strong positioning indicates a company is executing well on a sound strategy.
Reviewing a company’s website, earnings reports, press releases, and other investor relations materials will help you identify its focus areas. News articles also provide color on major products.
Having a handle on the business model sets the groundwork for analyzing everything that follows.
2. What is the financial health and performance of the company?
The second question you should ask before buying a stock is what the financial health and performance of the company is. This will help you assess the company’s profitability, growth, and stability.
You should analyze the company’s financial statements, such as the income statement, balance sheet, and cash flow statement. You should also look at some key financial metrics and ratios, such as revenue, earnings, margins, debt, cash flow, return on equity, return on assets, and more.
You should compare the company’s financials with its past performance, its industry peers, and its expectations. You should also look for trends, patterns, and anomalies that may indicate the company’s strengths or weaknesses.
Key metrics to analyze include:
- Revenue and earnings growth: Examine historical trends over the past 5-10 years. Look for steady, consistent growth over time rather than erratic swings.
- Profit margins: Higher margins indicate a company is efficient at converting revenue into profits. Trend margins over time and vs. competitors.
- Return on equity: This measures how much profit a company generates from shareholder equity. ROEs above 15% are favorable.
- Debt levels: Companies with high debt have greater risk. Conservative debt positions give more flexibility.
- Cash flow: This directly represents money flowing in and out of the business. Cash flow should be consistently positive.
Ideally, you want to see growing revenues and earnings, high and expanding margins, respectable ROE, moderate debt levels and solid cash flow. These signal an enterprise with financial strength and discipline. SEC filings, earnings reports, and financial sites like Yahoo Finance offer this data. Comparing a company’s metrics to competitors gives more context.
3. Who is leading the company and what is their track record?
Warren Buffet famously said he evaluates company management before investing:
“I try to invest in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.”
The third question you should ask before buying a stock is who is leading the company and what is their track record. This will help you evaluate the company’s leadership and management team, their vision, strategy, and execution.
You should research the company’s CEO, CFO, and other key executives. You should also look at the company’s board of directors and their backgrounds. You should check their qualifications, experience, reputation, and performance. You should also look for any red flags, such as scandals, lawsuits, or conflicts of interest.
You should also look at the company’s culture, values, and ethics. You should see if the company has a clear mission, vision, and goals. You should also see if the company treats its employees, customers, suppliers, and shareholders well.
Background checks should include:
- Who is the CEO? Review their education, experience, tenure and past roles. Look for a solid track record.
- Who are the other executives? Research their backgrounds as well. Depth of experience is just as critical.
- Do they have extensive industry experience? Expertise specific to their company’s market is ideal.
- Have they led other major companies before? A history of executive leadership elsewhere is reassuring.
- Do they have high approval ratings? Management hated by employees damages culture and performance.
- What is their compensation structure? Overpaid executives or misaligned incentives are red flags.
Leaders with long, accomplished careers in their industry are what you want to see. This demonstrates the skill and knowledge needed to drive future growth.
For example, if you are interested in buying Netflix’s stock, you should know that the company is the world’s leading streaming entertainment service, offering a wide variety of TV shows, movies, documentaries, and original content. Its CEO is Reed Hastings, who co-founded the company in 1997 and has led its transformation from a DVD rental service to a streaming giant. Its CFO is Spencer Neumann, who joined the company in 2019 and has overseen its financial growth and expansion. Its board of directors includes prominent figures such as Susan Rice, former U.S. national security advisor, and Anne Sweeney, former co-chair of Disney Media Networks. The company’s culture is based on its core values of freedom, responsibility, innovation, and excellence. The company has a clear vision of becoming the best global entertainment platform and a strong strategy of investing in original content, expanding internationally, and improving user experience.
4. What is the outlook for the industry and market trends?
The fourth question you should ask before buying a stock is what the outlook for the industry and market trends is. This will help you determine if the company operates in a growing, stable, or declining industry. It will also help you identify the opportunities and threats that the company faces in its external environment.
You should research the industry size, growth rate, and segmentation. You should also look at the market trends, such as consumer preferences, technological innovations, regulatory changes, and competitive dynamics. You should see how the company adapts to these trends and how it differentiates itself from its rivals.
Key questions here include:
- How large is the total addressable market? Billions in potential sales indicate room for growth.
- What are the projected growth rates for the industry? Faster is better.
- What market share does the company have? Higher shares signal competitive strength.
- Who are the major competitors? Look for many smaller ones rather than a few huge rivals.
- What are the key industry drivers and trends? Favorable ones lift all boats.
- What disruption risks does the industry face? Major threats like technology shifts damage all players.
- Does the industry depend heavily on the economic cycle? Cyclical industries face more volatility risk.
For example, if you are interested in buying Starbucks’ stock, you should know that the company is the world’s largest coffeehouse chain, offering a variety of coffee, tea, and other beverages, as well as food and merchandise. The global coffee industry is expected to grow at a compound annual growth rate (CAGR) of 4.2% from 2020 to 2027, reaching $134.25 billion by 2027. The market trends include the rising demand for specialty coffee, the increasing popularity of online ordering and delivery, the growing awareness of sustainability and social responsibility, and the intensifying competition from both local and global players. Starbucks leverages these trends by offering high-quality coffee, expanding its digital and loyalty platforms, investing in environmental and social initiatives, and innovating its products and services.
Industry analysis establishes the runway for future growth. A company thriving in a stagnant business has lower upside.
5. Does the company have a competitive advantage?
Within a quality industry, the most successful companies maintain competitive advantages over rivals. This edge defending them from competition and boosts profitability.
The fifth question you should ask before buying a stock is whether the company has a competitive advantage. This will help you evaluate the company’s ability to sustain its market position and profitability over time.
A competitive advantage is a unique strength or edge that a company has over its competitors. It can be based on factors such as product quality, innovation, customer service, brand loyalty, cost efficiency, or network effects. A competitive advantage can create value for customers and shareholders, and can be hard to replicate or imitate by rivals.
You should look for evidence of the company’s competitive advantage in its financial performance, customer satisfaction, market share, and industry recognition. You should also look for potential sources of competitive advantage in the company’s resources, capabilities, and strategies.
For example, if you are interested in buying Amazon’s stock, you should know that the company is the world’s largest online retailer, offering a wide range of products and services, such as e-commerce, cloud computing, digital streaming, artificial intelligence, and more. Amazon’s competitive advantage is based on its customer obsession, innovation, scale, and diversification. Amazon delivers value to its customers by offering low prices, fast delivery, convenience, and selection. Amazon also invests heavily in research and development, constantly launching new products and services, such as Alexa, Kindle, Prime, AWS, and more. Amazon benefits from its massive scale and network effects, as it has over 300 million active customers, over 200 million Prime members, over 1.5 million sellers, and over 175 fulfillment centers worldwide. Amazon also diversifies its revenue streams across multiple segments and geographies, reducing its dependence on any single market or product.
Important sources of competitive advantage include:
- Proprietary technology or processes like Coca-Cola’s secret formula or Google’s search algorithms. These unique innovations can’t easily be copied.
- Visionary leadership like Tesla’s Elon Musk who transforms industries with disruptive thinking.
- Strong brand reputation provides customer loyalty and pricing power like Apple enjoys.
- Network effects happen when more users join a platform increasing its value like Facebook or eBay.
- Economies of scale from massive size generate higher margins like Walmart benefits from.
- Regulatory approvals or patents erect legal barriers against new entrants.
- High switching costs make it expensive for customers to change vendors.
Not all competitive edges are sustained forever. However, companies with multiple, durable advantages have winning business models. This leads to higher and more consistent profits over the long term.
6. Is the stock valuation reasonable?
Before investing, it’s critical to determine if the share price aligns with the company’s fundamentals. Even great businesses can be bad stock investments if overvalued.
You should look at the company’s historical and projected growth rates, both in terms of revenue and earnings. You should also look at the company’s growth drivers, such as new products, new markets, new customers, new partnerships, etc. You should see if the company has a clear and realistic growth strategy and if it can execute it well.
You should also look at the company’s future opportunities and challenges, such as emerging trends, technological disruptions, customer needs, competitive threats, etc. You should see if the company can capitalize on these opportunities and overcome these challenges.
For example, if you are interested in buying Facebook’s stock, you should know that the company is the world’s largest social network, connecting over 2.8 billion monthly active users across its platforms, such as Facebook, Instagram, WhatsApp, Messenger, and more. The company’s revenue grew by 22% in 2020, reaching $86 billion. Its earnings grew by 58% in 2020, reaching $29 billion. The company’s growth drivers include increasing user engagement, expanding its advertising business, diversifying its revenue sources, such as e-commerce, gaming, virtual reality, and more. The company’s growth strategy is to build the best products to connect people, empower businesses, and create social value. The company’s future opportunities include tapping into emerging markets, such as India and Africa, leveraging its data and artificial intelligence capabilities, and developing the next generation of computing platforms, such as the metaverse. The company’s future challenges include facing regulatory scrutiny, privacy concerns, content moderation issues, and competition from other platforms, such as TikTok, Snapchat, and Twitter.
Several metrics help assess valuation:
- P/E ratio: The share price divided by earnings per share. Lower P/Es represent better value.
- PEG ratio: P/E divided by projected earnings growth rate. Lower ratios indicate cheaper growth stocks.
- P/S ratio: Share price divided by sales per share. This gauges value for unprofitable companies.
- P/B ratio: Stock price relative to book value per share. This measures asset value coverage.
- P/CF ratio: Share price vs. cash flow per share. Cash flow-based valuations are useful.
- EV/EBITDA: Enterprise value compared to earnings before interest, taxes, depreciation, and amortization.
Compare these ratios against the industry and historical averages. Use multiples the business can reasonably justify based on past and expected performance.
Paying fair value for phenomenal companies is better than overpaying for mediocre ones. Patience pays off.
7. What is the expected growth rate over the next few years?
The seventh question you should ask before buying a stock is what the expected growth rate over the next few years is. This will help you project the future earnings and value of the company.
You should look at the company’s earnings per share (EPS) growth rate, which measures the percentage change in the company’s earnings per share over a given period. You should also look at the company’s revenue growth rate, which measures the percentage change in the company’s revenue over a given period. These growth rates can be calculated based on the company’s historical or forecasted data.
You should compare the company’s growth rates with its industry peers, its historical averages, and its expectations. You should also look for consistency, sustainability, and acceleration in the company’s growth rates. You should avoid companies that have negative, erratic, or declining growth rates.
You should also look at the company’s price-to-earnings (P/E) ratio, which measures the price of the stock relative to the earnings per share. You should also look at the company’s price-to-earnings-growth (PEG) ratio, which measures the price of the stock relative to the earnings per share growth rate. These ratios can help you determine if the stock is overvalued or undervalued based on its growth potential.
For example, if you are interested in buying Google’s stock, you should know that the company is the world’s leading internet company, offering a range of products and services, such as search, advertising, cloud, YouTube, Gmail, Maps, and more. The company’s EPS growth rate was 12.8% in 2020, and is expected to be 18.4% in 2021, and 16.9% in 2022. The company’s revenue growth rate was 12.8% in 2020, and is expected to be 23.5% in 2021, and 19.1% in 2022. The company’s growth rates are higher than its industry peers, its historical averages, and its expectations. The company’s growth rates are also consistent, sustainable, and accelerating. The company’s P/E ratio is 29.6, and its PEG ratio is 1.6. These ratios indicate that the stock is fairly valued based on its growth potential.
Buying a stock equals buying future earnings. Investors are willing to pay higher valuation multiples for stocks poised for faster growth. Consider both:
Company specific growth
- New products or markets expanding TAM
- Improving margins
- Technology disruption ahead of competitors
- Potential M&A target
General growth
- Projected GDP, population, wage growth
- Industry growth forecasts
- Macro trends like cloud computing or e-commerce
Analyst revenue and earnings estimates provide clarity on expectations. Consistently beating estimates confirms execution.
Look for 10%+ annual growth rates if possible. Growth undergirds increasing dividends and stock gains. Slow growing companies make poor investments.
8. What are the major risks or headwinds facing the company?
Avoiding losses is equally important as chasing gains. Hence, prudent investors research potential risks threatening the business:
- Lawsuits or legal actions
- Increasing competitive threats
- Slowing demand
- Disintermediation from newer technologies
- Loss of key strategic partners or customers
- Supply chain disruptions
- Political or regulatory changes
- High debt levels
- Bad publicity or scandals
Catching flags early allows you to project impacts on future cash flows and management strategy. Most risks present opportunities for companies with solid leadership that adapts. But some present existential threats requiring avoidance.
9. How does the stock fit your investment goals and time frame?
Take a final pass evaluating how purchasing the stock aligns with your investing approach:
- Investment thesis: Does the opportunity match your strategy?
- Risk profile: Do potential rewards justify possible risks?
- Diversification: Will the stock help balance your overall portfolio?
- Time horizon: Can you wait for the thesis to play out fully?
- Income needs: Does the dividend or total return fit goals?
For example, risky biotech stocks match a speculative growth strategy. They don’t fit low-risk retirement accounts needing income.
Matching stocks with compatible goals increases your chances of investing success.
10. Are company insiders buying or selling the stock?
Corporate executives and directors often receive stock compensation. That gives them skin in the game. Monitoring insider trading activity can provide clues:
- Buying activity suggests insiders see the upside ahead.
- No trading indicates confidence in the current valuation.
- Selling may signal elevated risk factors or peaking growth.
However, there are many valid personal reasons for insider transactions like diversification or liquidity needs. So use this as one input, not the sole basis for decisions.
Conducting Stock Research Takes Time, But the Payoff Is Worth It
Thoroughly researching any company you invest in takes time and diligence. Valuing long-term gains over short-term frictions is critical. Building conviction through stock research helps you hold through volatility when tested.
While this checklist covers the key areas, analyzing successful companies is a lifelong endeavor. Experience observing different market environments and business models compounded over decades makes skilled investors.
Embrace investing research as a journey, not a one-time event. Your portfolio will benefit from the continuously deeper knowledge you accumulate over time.
Stay tuned for more articles on how to research stocks, evaluate company fundamentals, and become a savvier investor. Thanks for reading and good luck with your future stock picks!
2 thoughts on “10 Key Questions to Ask Before Buying a Stock”