Questions to ask when you invest in companies
22 March 2021
So you’ve decided to invest in companies. Great! But now what? Investing in companies is about choosing things that give you a shot at the returns you want, in a desirable time horizon (how long you expect to keep your money invested for), while taking risks you’re comfortable with.
Here are some questions to ask yourself when you’re choosing a company to invest in. These questions are a jumping-off point. There are other things you may think about as well, but these should get you started.
The different kinds of returns
Investing in companies tends to give two different kinds of income:
Dividends—when companies give shareholders a portion of the profits, or
Capital gain—when shareholders sell their shares for more than they paid for them.
(You can read more about these two different kinds of returns in this Investopedia article.)
This isn’t an either/or situation—it’s a spectrum. Some companies give a portion of their profits back to their shareholders, and invest just a little bit in growth. Other companies invest more in future growth, and don’t give as much back to shareholders as dividends.
Sometimes, a company might decide not to pay a dividend. They might not have made enough money to pay one, or they might be facing a lot of uncertainty about the future—say, after being hit by a global pandemic.
Finally, you may want to look at the different tax implications for different companies. These may be different, so you may want to seek advice. After all, the taxes you pay can ultimately affect your returns.
If you don’t have a preference, that’s okay! You can just invest in a few different companies based on other criteria.
What does your whole portfolio look like?
Once you invest in companies, they become part of your investment portfolio—just like any existing investments you may have. Think about what the rest of your portfolio looks like at the moment, and how it might change if you decide to invest in companies.
If you’re looking to diversify away from the rest of your portfolio, you might decide to explore the idea of investing in companies that are different from the things you currently own. Alternatively, if you’re looking to double down on the strategy you’re following in the rest of your portfolio, you might look for something that closely matches your current investments.
This also applies to risk and time horizons. You might want to take on a bit more risk compared to the rest of your portfolio, or you might want to take on a bit less. As always, the direction you choose and what you decide to invest in is up to you. We would always recommend that you do your own research on these topics.
How has the company been performing?
This section has to come with a bit of a warning: remember that you cannot predict the future. Any company can gain or lose lots of value tomorrow, regardless of what it’s done for the last 10 days, months, or years. Past performance does not predict future results.
Having said that, you can compare how different companies performed at points in their past. For example, let’s say you have two companies. Over the past five years, the first company’s share price has hovered around $3 per share. It’s gone up to $3.20 before, and it’s gone down to $2.90, but it has never moved any further than this in either direction. It’s been pretty stable.
The second company is a different story. It was $4 per share last month, $6 per share the month before that, $2 per share before that, and a whopping $10 per share the month before that! It’s all over the place.
Now, you cannot predict what’s going to happen tomorrow—not with any certainty, at least. But when you compare the two companies’ past share prices, you can see the second company’s price has fluctuated a lot more over time than the first. This fluctuation is known as volatility.
As the second company’s share price has fluctuated more wildly—going up one month, then down the next—it’s considered to have high volatility. The first company’s price has been relatively stable, so it’s considered to have low volatility.
The second company’s high volatility share price makes it a riskier investment. But its higher risk might come with a higher chance of its share price going up or down.
You may also decide to look at news reports about a company. Have they been doing what they said they were going to do? Have they met any targets they set for themselves? These things are important, and can give an indication of how well they’re performing.
Do you have knowledge you can put to work?
Everyone has specialised knowledge of some variety. You might work in a particular industry, and live and breathe it in a way that other people don’t. Or you might be especially interested in a certain product or technology, and have read heaps about it. You might have noticed that everyone around you is using a product or service, and you think it’s going to take off. Or you might even have a hobby that gives you deep knowledge about something!
The point is, investing in companies is an opportunity for you to put your knowledge and experience to work. If you think something is going to take off in the future, you can invest towards that future—not only will you help bring it about, you might also get a good payoff if you’re right! If you don’t have this knowledge yourself, think about doing some research externally and learning more about what makes the company tick.
How does a company make you feel?
Now that you’ve narrowed it down a bit, do you recognise any names? There might be companies that you really support and want to see thrive in the future, or companies with an ethical approach that really matches your values. Perhaps there are companies that you just really enjoy doing business with—maybe the power provider you’ve had for ten years without a problem is in there.
These factors might be one of the things you consider when investing in companies, because investing can be about more than dollars and cents. It can also be about supporting companies that you want to see succeed in the future.
Investing in companies can be an opportunity to chase the returns that are most meaningful to you. This might be financial, but it also might just be the ‘return’ of living in a world where you do business with companies you know, respect and value. So don’t forget, this last point is a real opportunity to help create a future you want to live in.
Now that we’ve worked through it, you can see that investing in companies is not so overwhelming after all. There are lots of things to think about when exploring what to invest in, including risk tolerance, goals, time horizon and values. You might like to have a think about these things and we always recommend you do your own research to gain more insight into these factors and other considerations.
Ok, now for the legal bit
Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written. You should consider seeking independent legal, financial, taxation or other advice when considering whether an investment is appropriate for your objectives, financial situation or needs.