A five point checklist for safer stock market investment

While the stock market is currently more volatile than it has been for a while, now may be the time to allocate more of your portfolio to small caps and micro-caps.

This is not a blanket statement. Utmost caution should be applied and with very little coverage or media attention given to these stocks, which small cap company to invest in can be a difficult decision – certainly more difficult than which blue chip to put your hard earned money into.

The fact is most small cap stocks make for poor investments, so seek financial advice, do your own due diligence and then devise a strategy to help you pick the few you have confidence in.

Of course, this is a basic checklist and applies to all stocks. However, it will make your small cap selection easier.

The five point checklist for better investing

1. Buy right – a low price may not be a cheap price

That’s right, just because a stock price is at a low ebb, doesn’t necessarily mean it’s cheap. What you want to look at is the value of the investment. Take a look at how many shares are on offer, combine that with the market capitalisation —what the market thinks the company is worth – and then factor in the company’s assets, its earnings or potential for future earnings, and its peers. Peer comparison is important. If the company you are looking at has similar assets and earnings, then it’s worth asking why the company you are looking at is priced below peer value.

2. Know what you’re investing in

You may have heard about a company through a friend, or read about it in an article, however what do you really know about the company? The questions you need to ask if considering an investment are: what industry does the company operate in? Do you understand the industry? How does the company make money? If it isn’t making money, how does it plan to make money? Is it turning a profit? What are the outgoings compared to the incomings? Is it being used just to pay management’s salaries? When is it forecast to make a profit? Understand the business, before investing in it and if you don’t understand it, find a business you relate to.

3. Know who’s running the company

The success of any company is in large part down to the management team. This is especially the case with small companies (listed or not). It is imperative you check the background of all directors in the company. Examine their track record: have they been previously responsible for running a successful company, or involved in major company transitions. If you find a director’s past to be questionable, get out before it’s too late. One final thing to take into account is how much ‘skin in the game’ a director has. This means how much a director is invested in the company. A director’s interest can be highly revealing: every time a director buys or sells shares, it has to be reported to the ASX within three days. You can review the latest Appendix 3Y to make sure that management isn’t bailing and selling up. While doing this, it is also worth checking who the major shareholders are. Not only should you be looking for how many shares managers have, but the power of other investors including large fund managers, foreign billionaires and even rich listers.

4. How much cash does a company have?

Cash flow statements are important, particularly for small capped businesses. A clear picture of revenues, expenses and cash backing, will indicate the true cash profitability of a business, and if or when it might need to raise capital. Does the company have sufficient cash in the bank to fund its growth, or does it need to raise capital? Raising capital will often dilute your shareholding. Not all capital raisings are bad, however. If the company has a tangible growth strategy and you can see what the cash will be used for, don’t throw it on the trash heap just yet.

5. What do the share price fluctuations mean?

Buying stocks when the price has fallen to a record low, or is in a steady downtrend may not be the best idea. You wouldn’t catch a falling knife, right? It’s not out of the question to do so, but you’ll need good reasons. For instance, a new management team could turn the business around, along with a strong acquisition strategy, or overall improvement in the general sector. Essentially there are two things to consider when looking at what might affect the share price: is there a reason for long term negative impact or are market fluctuations causing the price to dip. If it’s the latter, this could present a buying opportunity, but you should seek professional financial advice before making that decision.

This update is not financial advice. This article is general news and information.

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