Investing

There are many ways to pick shares. Some people believe that studying the shapes and patterns of stock price charts can reveal the right time to buy and sell. Others look to buy the companies that look best positioned to profit from an emerging business trend.

The paradox of simplicity

At Financial Review Smart Investor we believe the best way to make money over the long term is to invest in quality businesses at a good price. That’s simple to say but devilishly hard to do – especially without the right tools, knowledge and attitude.

Here, you’ll find some guidance to get you on the road to investing success, starting with the obvious: know what you’re investing in.

Not such a stupid question

Imagine the following conversation:

Investor A: Hey, I just bought a business! It’s called Company X.

Investor B: Wow! That’s amazing! What does it do?

Investor A: Ummm … not really sure, but everybody reckons it’s great!

Sound ridiculous? Well replace Company X with Babcock & Brown or Allco and suddenly that dialogue starts to sound less like fiction and much more like history.

Of course, neither of those two stories ended well for investors – those businesses were swept into the bin of corporate history by the global financial crisis.

So, learn about the company’s business.

Pretend you’re the owner

That points to a related lesson much beloved of investment guru Warren Buffett and his many, many disciples: think like an owner.

A company may well have a number of business lines, potentially operating in different parts of the country and even the world.

Which ones account for the bulk of revenue? Which are the fastest growing?

Familiarise yourself with management’s strategy by looking at financial statements, annual reports and other updates posted on the ASX website.

You’ll find these at www.asx.com.au/research/company-research.htm or in the investors section on the company website.

Top people at the top?

While you’re at it, try to get a feel for the people running the business. It’s great to have an experienced and stable executive team that knows the business inside out.

Check also whether the strategy is clear and doesn’t change on an annual basis.

And you should spend some time getting to know the corner of the economy in which a company operates.

Industries can be prefixed with one of three terms: growth, mature and – less common – declining. These describe what stage of the economic life cycle the industry is in.

Sure, you can have rapidly expanding companies operating in a mature industry, and slow-growing ones operating in a growth industry, but if you had your druthers you’d prefer a company to be competing for an expanding pool of total revenue.

Australia is a Noah’s Ark economy – it’s small and you find duopolies (or oligopolies in the case of the banks) in many sectors (think supermarkets, department stores, mining, telecommunications and media).

So unless you’re investing in one of the blue chips (big, well-established companies such as the banks or Woolworths or BHP Billiton) what you’re looking for is a niche business which is the leader in its field and able to maintain that position.

The long-term view

Ask yourself this question: “how likely is it that this company will be around in 10 years, and will it be more valuable then?”

It’s also useful to group businesses into those which depend heavily on the business cycle, and those whose operations are more independent of the ups and downs of economic conditions. The former are known as “cyclical” businesses, the latter “defensive”. Media companies, for example, rely heavily on the prevailing environment. Healthcare businesses, less so (although no company exists in a bubble).

All other things being equal, you’d like a company to be the master of its own destiny as much as possible.

A couple of hints

Make sure you read the past few annual reports (and don’t forget the notes to the accounts).

A couple of hints: look for evidence that the business is generating and growing cash. Also, strong financial foundations are a must, so check the company isn’t heavily in debt. Successful investing is as much about avoiding disasters as picking winners.