Seven Questions To Ask Before Buying A Stock

Henny Ray Abrams

Being in the financial news business for the last 20 years, I certainly know how much information is available out there.

I also know it can be overwhelming for investors to make heads or tails of it all.

You have press releases, company websites, comments from analysts, rumors and news reports from which you can gather information about a company.

That’s why you need a plan before you dive in. You have to be able to quickly and decisively separate the real news from what I call “the noise.”

How do you determine which is which? You begin by asking the right questions.

Seven Questions to Separate News from Noise

While I ask a lot of questions when I’m researching a company, I have found these seven questions are always at the top of my list. These questions not only help you gather key data, but also help you put the data into context—a critical part of separating news from noise.

1. How does the company make money? Always examine the revenues of each segment of the business to see how much it contributes to the overall earnings. For example, if a company is in the computer business, it’s important to know how much of its sales are from personal computers versus software support.

2. Where is the company’s growth coming from? If a company derives 50% of its revenue from semiconductors and industry growth has fallen 10% from a year ago, you need to take a closer look.

I always want to know where the company’s next three years’ worth of growth will come from. The answer will lead you to discover new products in the pipeline, new production synergies, etc.—key factors for putting the company’s growth in context.

3. Who are the customers? Once you know who the customers are, you can see who the company is counting on to continue its growth. How many customers does the company have? Does it have a wide geographical reach? If it relies on one large customer, then it is vulnerable if that customer cuts orders. When the customers are individual consumers, you should always gauge customer satisfaction and demand.

Investor Spring Cleaning - A CNBC Special Report
Investor Spring Cleaning - A CNBC Special Report

4. Who is the competition? No company exists in a vacuum. While there are companies with similar (sometimes downright identical) business models, each has its own strengths and weaknesses. That’s why it’s important to examine how competing companies within a sector stack up.

5. What do the suppliers and vendors say about the company? Does the salesperson at Best Buy say no one’s buying PCs and they are piling up in the warehouse? Can you connect that to another piece of data that indicates sales could be slowing? You are not always going to find buy and sell signals by walking around your neighborhood— but in my experience, where there’s smoke, there’s fire.

6. Who is running the company? It’s vital to examine the management team’s track record. How long has it run the company? How has the stock performed? If it hasn’t done well, how much of that is due to an industry downturn or the overall economy, and how much is due to leadership? Be sure to get a handle on what the company has promised as far as earnings, revenues and growth targets, and check to see if management has delivered.

7. How promising is the overall economic environment? When you’re analyzing companies, it’s important to put the business into perspective relative to the overall economic environment. Where is the current economic growth coming from, and where do the industry and company you’re following fit in?

The next time you’re thinking about buying a stock, be sure to ask these seven questions. You’ll avoid reacting (or overreacting) to the noise on Wall Street, and instead stay focused on the real news.

More Great Reads On Including: