Ask Key Questions when Selecting Stocks

Physician's Money DigestMarch31 2004
Volume 11
Issue 6

When it comes to buying a car,most of us will take severalprospective models out for atest-drive, kick the tires a few times, andhaggle with the salespeople as we gofrom dealership to dealership comparisonshopping. We do the same withvacations, scouring the Internet insearch of the best deals on airfares andhotel accommodations.


So why don't we make the same sortof effort when it comes to investing instocks? There is no magic answer as towhy we behave so irrationally. But if wewould simply apply a small amount oftime and energy to researching a stockbefore making a purchase, an article in suggests, we might be aspleased with our stock selections as weare with our vacations.


According to the article, thereare several key questions to ask beforemaking a stock-purchasing decision,including the following:

  • How does the company makemoney? For example, we all know thatGeneral Motors (GM) sells millions ofcars each year. But in fact, the bulk ofthe company's earnings come throughits financing arm, GM Acceptance Corp.And half of those earnings come fromresidential mortgage loans, not carloans. That's information about thecompany's risks and potential profitsyou should be aware of.
  • How does the company comparewith its competitors? If the company isin a high-growth industry, such as videogames, are sales growing as rapidly asthose of the competition? In a moremature industry, is the company at leastholding its own? Be sure to keep inmind the costs a company must bearcompared with its competitors. GM andFord, for example, have significantoverhead from pension and health carecosts for retirees, something thatToyota and Honda do not have.
  • What is the economy's impact onthe company? Fortune points out thatduring a downswing, the stocks ofpaper companies look cheap becausenewspapers and magazines cut back ontheir advertising, so paper companiessell less paper. When interest rates drop,more people purchase or refinance ahome, which benefits homebuilders andappliance manufacturers. But if interestrates rise, those industries could seegrowth dramatically slow down.
  • Who's the boss? That's the questionyou want to have answered aboutthe company whose stock you're consideringpurchasing. And not just who, buthow capable is company management?In the Fortune article, Mike Mayo, aPrudential Financial bank analyst, suggestsreading several years' worth ofannual report letters that CEOs write toshareholders. Is the message consistentor is strategy consistently changing? Ifit's the latter, you may want to considerpurchasing a different stock.
  • Do you really need to own thestock? There are approximately 15,000publicly traded stocks available on USexchanges, according to Fortune, andone is not necessarily more essential toown than another.

Take some time, do the research, andanswer the questions listed above. You willhave that much more peace of mind whenyou're lying on the beach at your vacationdestination of choice.

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