Weigh­ing up the pros and cons of a stock We take a closer look at how to de­ter­mine whether a com­pany is wor­thy of a place in your in­vest­ment port­fo­lio.

Finweek English Edition - - MARKET PLACE - Editorial@fin­week.co.za

oneof the most im­por­tant points of in­vest­ing is how we get to that fi­nal de­ci­sion about whether to buy a stock for in­clu­sion in our in­vest­ment port­fo­lio. It is vi­tal that we do not just act on a whim or a sin­gle piece of news or data. Sure, maybe the man in the nice shiny suit on TV rates it a buy, or the know-it-all on some chat fo­rum says it’s go­ing to be a 10-bag­ger. Cer­tainly these opin­ions can be used as start­ing points, but we need to build a body of ev­i­dence to sup­port the pur­chase de­ci­sion.

I call it my pre­pon­der­ance of ev­i­dence. Gen­er­ally, there is one thing that will ini­tially at­tract me to a share: it may be a great div­i­dend yield or a his­tor­i­cally low price-toearn­ings ra­tio (P/E), great re­sults or maybe even the shiny suit on TV – but what­ever it may be, that is merely the first step. Now that we have a start­ing point, we need to do more dig­ging into the share and its in­vest­ment po­ten­tial. I typ­i­cally start my dig­ging with just a blank piece of pa­per.

List­ing pros and cons

On the left side of my pro/con list, I write down the good points for in­vest­ing in the stock and on the right I write down the risks – the rea­sons for not in­vest­ing in the stock. As I go along do­ing my re­search into the com­pany, I write down more in­for­ma­tion in these col­umns.

When I run out of pa­per, or run out of stuff to dig through, I stop and ex­am­ine the ev­i­dence be­fore me. There will al­ways be rea­sons not to in­vest (the risks) be­cause in or­der for there to be re­ward there has to be risk. But what is very im­por­tant is that the good bits sig­nif­i­cantly out­weigh the bad bits. I want a pre­pon­der­ance of ev­i­dence that this is a good com­pany to in­vest in.

If my list is dom­i­nated by bad news and risk with very lit­tle good stuff, then the in­vest­ment is sim­ply far too risky and I will walk away. But if the good stuff dom­i­nates, then I’ve found some­thing worth buy­ing.

What makes a stock at­trac­tive?

The next step in the process is to high­light the top two or three good points for mak­ing the in­vest­ment. These then act as my exit strat­egy. They were the key rea­sons for en­ter­ing the in­vest­ment and hence if they change for the worse, they be­come my rea­sons for ex­it­ing – in trader speak, my stop-loss on the in­vest­ment, al­though it is based on the fun­da­men­tals of the stock rather than the price. So for ex­am­ple, if one of the main at­trac­tions was a great mar­gin and this mar­gin starts slip­ping, I have to con­sider ex­it­ing. I am never quick to exit, and one re­port­ing pe­riod of re­duced mar­gins will not worry me, but re­peated slip­ping mar­gins would con­cern me.

Up­date your find­ings reg­u­larly

Lastly, when I am fin­ished with the process, I file the piece of pa­per away, I don’t toss it. On it is my re­search and my exit strat­egy – I need to keep it as the in­vest­ment may run for years or even decades, and as the years pass I may not re­mem­ber what drove me to in­vest in that par­tic­u­lar stock in the first place.

An im­por­tant point is that I will re­visit the list ev­ery time there are re­sults or other im­por­tant news com­ing out of the com­pany. When there is news, I up­date my list, adding pros and cons. If the neg­a­tive as­pects in­crease and start to out­weigh the pos­i­tive ones, this would be a rea­son to exit, but if the good con­tin­ues to dom­i­nate then I will keep hold­ing the stock.

On the left of my pro/con list, I write down the good points for in­vest­ing in the stock and on the right I write down the risks – the rea­sons for not in­vest­ing in the stock.

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