March 19: Five Questions Leading to Successful Stock Purchases

by David Jenyns on March 19, 2007

In order to become a knowledgeable investor, there are certain aspects about stocks that you must become familiar with. Remember that knowledge is power, so the more you know about the stock you are about to purchase, the better you chance is on receiving a high return on your investment. There are seven guiding questions that will provide the answers about each stock that you consider buying.

1. What is the source(s) of the company’s cash flow(s)?

To properly answer this question about the company you are considering to purchase stock from, it is important to be as specific as possible, but most importantly, avoid making assumptions in order to know the exact cash flow of the given company. It is important for the investor to know about a company’s cash flow because it determines which stock is the best to buy. For example, Betty Crocker baking mixes are predominately sold in all discount stores across America, therefore, it is easy to assume that this is the company’s main cash flow. Through further research, you discover that Betty Crocker also sells their recipes to catering companies throughout the world and that most of their cash flow comes from this venture. Therefore, the conclusion would be to purchase stock in the part of the Betty Crocker company that sells their recipes to catering companies so that you can gain the highest return on investment.

2. How much cash is generated by the company and when?

Once you, the investor, has recognized the highest cash flow of any given company, you must estimate the total amount as well as when the cash flow takes place. For example, you estimate that Betty Crocker makes $25,000 per day during the month of December. As times goes on, this $25,000 will grow each December due to inflation, concluding that during the month of December, sometime in the future, is the best time to cash in your stocks.

3. How much money does the company require to function?

Depending on the company, some businesses require more capital in order to generate profit. The less capital it takes to operate a business, the more attractive it is to an owner. The more attractive a company is to buy, the better the chance of selling the company to a businessman that would make the company become a noticed establishment in the economy, which in turn, increases the return rate on the stock.

4. Does the management of a company have a friendly shareholder orientation?

The way in which the management of any given company decides to treat its shareholders is the direct determinant of its success in the stock market. The better the shareholders are treated by the company, the more likely the shareholder will either buy more stock or refer other people to purchase stock for the company. A good way for management to ensure friendly relations with shareholders is to keep the shareholders informed as to when the return rate of the stock is going to increase so that they are able to purchase more stocks, and, thus, make more money.

5. Are the actions of the management of a certain company consistent with what they say in public?

Basically stated, the more honest the management is with any company, the more shareholders they will gain. For example, 5 members of management of a given company give a public speech declaring that the return rate on their company’s stock is about to increase. So, shareholders begin to purchase more shares in their company. However, later, the 5 members of management have a public meeting, stating that they really lied about the return rate increasing to persuade people to buy stocks so that their company could gain more money, then the trust level of their stockholders has just decreased, and they would more than likely sale their stocks in retaliation of being lied to in order to make that company fail in the stock market. Therefore, it is highly important for companies that sale stock to be honest at all times with their shareholders.

By answering these five questions with information that you have obtained while researching a certain company, the better your chance is of gaining a return on your investment if you decide to buy stock from an honest, reputable company.

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