-- Do I even understand what this business does? When a business is too complicated to explain in a few sentences, this can signal risk. It tends to be the case that there are more things that can go wrong with complex operations. I'm reminded of Enron, who didn't even disclose how they supposedly made money. When asked, they basically replied "don't worry about it". I'm amazed how many large investors took their word for it.
-- Who are the competitors and why aren't they better investments? If a business looks like a good investment, perhaps there are competing operations that are even better. Studying competitors can also help an investor contextualize the opportunity and provide conviction for the original idea. Many industries use common benchmarks for financial metrics.
-- Is the management team trustworthy? There are plenty of legal ways to manipulate financial statements using accounting tricks. We find that when companies use conservative policies and assumptions, they tend to perform better in the long run. Beware of CEOs who constantly talk up their stock while promising growth which never measures up to the hype.
-- What would the worst case scenario look like? Thinking hard about potential risks can help avoid losses. For a research-stage biotech company, this might mean the science won't ever work and no pharmaceuticals will be commercialized. For a utility company, this might mean a recession results in a temporarily reduced dividend.
-- Is this the best use of my capital? A lot of beginner investors approach stock picking from the perspective of finding an investment that won't lose money. While this goal is certainly important, a better approach is to find investments that will provide the best return given the risk. Space in your portfolio is a finite resource, so it's best not to waste it on average stocks.
-- What are my shareholder rights? Nearly every class of shares provides dividends rights, because potential dividends represent the intrinsic value for equity investments. Traditionally, shares also provided rights to vote for the company's board of directors and on important policy changes. However, recently companies have been issuing shares that don't include voting rights. I'm astounded that investors have been accepting this arrangement.
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