Questions to consider

What's the state of the stock market?

It is not vital that the market be growing, however please don't forget that stock markets can be volatile. You should be aware that investor confidence in general is important when making a buy decision. If market sentiment suddenly turns against a particular sector or index, many companies can have value wiped off their shares irrespective of the underlying quality of a particular firm.

Is the sector growing?

There may be some sectors which interest you more than others. Perhaps you work or used to work in a certain field before, and you think that this might help you understand more of the ins and outs than the average investor. For each sector, learn as much as you can about the movers and shakers. Is there one particular company that is driving a lot of growth? Do all the firms contribute proportionately to the success of the sector? How is the sector performing against other sectors? Always be aware that past performance is no indication of future performance and you must try to assess the future prospects of the sector. What you should avoid is investing in a company that is in a 'hot' sector which everyone expects to grow but where it is not clear exactly how this company will contribute to the sector's growth.

What roles do companies play within the sector?

You could take the view that blue chip companies are the ones to invest in because they will make constant and steady cash flows, and show reasonable growth every year. These dominant firms are unlikely to make you spectacularly wealthy, but by the same token, the risk of them failing to post a profit or not growing at all is lower. An example of a company like this is Unilever.

However, recently market sentiment has moved away from these larger stocks into those which show much more aggressive rates of growth. For example, currently the market is favouring companies that invest heavily in Research and Development (R&D). They may not have large profits, preferring to use their resources for research. To judge the real value of this R&D, it can be useful to examine their successes, and the types of products, innovated in the past.

Is it profitable?

Historically, profit has been the ultimate measure of a company's quality. In the short term, high levels of growth or large acquisitions can severely undermine profits, but may lead to strong growth at a later date. Ultimately a company will have to make profit to stay in business. When looking at the profit figures, look at its absolute figure ,as well as profits as a percentage of sales revenues (margins). These figures should be compared with others in the sector.

Does it have a competitive advantage through e.g. licensing agreements or patents?

In some fields, possession of a licence or patent is crucial to sales success. If you consider that a pharmaceutical company can make billions of dollars from just one drug, you can see the value of being able to protect your intellectual capital through patents. Patents are awarded for various time periods such as 25 years. The time to expiry of the patent is extremely important because it gives a degree of certainty to future revenues.

Is the company well managed and does it have a clear vision for the future?

You should do background checks on companies that interest you. You can find the composition of the board of directors from the annual report. In it, you will very often find a mission statement, a vision for the future as well as a description of the business. Having done your research, does it seem likely that the present management can bring that vision into being? If you do not think the team is capable of delivering its promises, or if the vision for the firm does not strike a chord, then avoid it, as many other people may share your views.

Does it look undervalued vs. comparable firms?

Or if it is at a premium, is this justified? You have access to the information that makes analysis of a company's financial position possible. Using commonly available financial ratios, you can compare companies in the same sector. There is no exact science behind which ratio to choose and how to read it, but it can give a good indication.

Do you like its products and services?

It is all right to pick stocks in which you have a personal interest, although you may want to compare your picks against those of the experts. Whilst it may not seem very objective it can be a good indication if you yourself like the products. It is worth remembering that some of the best share performers over the long term have also been household names, such as Vodafone and Tesco.