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Choosing your first investment in 5 steps

Choosing an investment(s) can be a daunting task, but that’s where Simply Wall Street steps in. We focus on 5 key considerations to help you make well founded investment decisions;

  1. Value - whether a company’s shares are over or under priced compared to their “fair” value.
  2. Future performance -  expected future profit performance over 1 and 3 years based on analysts expectations and forecasts.
  3. Past performance - the company’s historical performance over 1 and 3 years.
  4. Health - the “health” of the company in terms of the amount of debt they have, and their ability to meet and service the debt.
  5. Income (or dividends) - the dividends being paid by the company, and its ability to maintain those dividends in the future.

Value

Warren Buffett once said “Price and Value are not the same”, and of course we certainly agree. We compare a company’s share price with our fair value measures, and highlight significant differences. We recommend that you look for shares where the current share price is significantly below fair value— that represents a potential opportunity to buy the shares at a discount. But make sure to consider all the other aspects of the company also — sometimes shares may be “cheap” for good reasons!

Past and Future Performance

Spectacular past or expected growth is clearly attractive, however this is not often sustainable over the long run. We prefer companies with steady, consistent historical profit growth in the top quartile of their peers, combined with future expectations for continuing profit increases.

Health

While companies may be able to sustain a high level of debt for a period of time, when conditions become difficult these companies can become distressed very quickly — there were many examples of this highlighted during the Global Financial Crisis (GFC).

Conversely companies with no debt, or at least low debt, have a better ability to withstand financial pressure or external shocks, and can take advantage of growth opportunities when they arise.

We therefore recommend companies with little or no debt, or at least those who hold sufficient cash to be able to significantly reduce debt in a short timeframe.

Income

High, sustainable dividends are very attractive for long term investors, however this raises an investment conundrum — high dividends often come at the expense of growth so ongoing share price increases will probably be modest. Finding companies offering both high growth and high dividends is a rare combination.

So we recommend that while you take income into account, consider all aspects of a company in combination, and don’t base your decision on the basis of the dividend alone.

One idea is to diversify your investments between companies offering potential high growth (often called “growth stocks”) and those paying high dividends (“income stocks”).

Management

Of course not every aspect of a company can be measured in a purely numerical way, so you should also think about the intangible factors. Some of Warren Buffet’s quantitative investment considerations are:

  • Is the company’s business easy to understand?
  • Is the company in a strong and growing market?
  • Does the company have an enduring and powerful competitive advantage? (or an Economic Moat to quote a phrase from Warren Buffett)
  • Does the company have a strong brand and consumer following ? (Warren Buffet for example has large investments in companies like Coca Cola and American Express).
  • Can the company control its sale price, or is it reliant on external prices? Resource companies for example are usually highly dependant on global prices for their products like Iron Ore, Gold and Copper, which they have little control over. Again from Warren Buffett;

“The single most important decision in evaluating a business is pricing power”

A few investment tips...

Be Patient..but act on opportunities

There is no need to rush in to invest so we suggest that you be patient with your investing, and wait for opportunities to arise where share prices are significantly below fair value for strongly performing, healthy companies. This can be a frustrating wait, but opportunities will come up and you will be rewarded for your patience over the long run.

The ‘grid’ of snowflakes in our app is a great way to quickly identify these opportunities. Click to see potential first time investments

Diversify your investments

Despite the best analysis and investing in the best possible companies, the unexpected can and does happen, so don’t put all your investing eggs in one basket. We strongly recommend that you diversify your investments to reduce your overall risk — think about diversifying across different sectors of the stockmarket (eg Banks, Resource companies, Software, Hardware) and perhaps also between high growth, steady as she goes and income paying investments.

Overall

Wrapping it all up, our app gives you a roadmap to the best investment opportunities and compares company share prices to their fair value to highlight potential discounts.

Look for snowflakes that score well across all categories, apply your own judgement and then patiently begin your investing journey.

Look for those snowflakes!

Next: Learn some common stock market myths to avoid