Scott shares: how to choose a company to invest inScott shares: how to choose a company to invest in

Scott Phillips is the Chief Investment Officer at The Motley Fool, where he’s provided share market commentary and stock analysis since the website launched in Australia in 2011.

Often, when people invest, they think about it as a ‘stock’—a ticker symbol, or a squiggly line on a chart. But what you’re actually doing is buying a (very!) small piece of a real business. A business that will hopefully continue to grow over time, and take your wealth on an upward journey with it.

So how do you choose which businesses to back?

Invest in businesses, not stocks

My approach is to find quality businesses with long-term growth potential, and buy their shares at a decent price. It’s important to focus on the actual company, not just some numbers on a screen.

Think about things like the business’s competitive position, quality of the management team, ability to find and dominate large markets, and strategy for the future. You can find a lot of this information in a company’s annual report.

Due diligence (also known as ‘doing your research’) means knowing enough about an investment before you buy it, and then keeping yourself informed.

Watchlist

Keep track of the investments you’re interested in or want to keep an eye on, with your own private Watchlist.

Learn more

Evaluate the company’s share price

I've never made a buy or sell decision based on a chart, or whether a company's share price is higher or lower than some previous point. Why? Because it's the future that matters, not the past!

What I do look at is what the share price implies about that future. How well would a company need to perform, from here, to make today's share price attractive?

There’s no shortage of metrics and ratios you can use, but the price-to-earnings (P/E) ratio is a pretty good start. Just make sure you understand the business and the sustainability of that 'E'—the company's earnings.

Price notifications

Get notified when an investment in your Portfolio or on your Watchlist reaches a price you set.

Learn more

Volatility isn’t the same as risk

With investing, nothing is certain. Every investment could go bad under certain circumstances. What investors should be trying to do is find a situation where the likely payoff is meaningfully higher than the risks they’re taking.

But also, remember that volatility is not the same as risk. Don't let the market tell you what to think. You only have to look at past share market volatility to see that it has no idea.

Focus on the business itself, and think like a business owner. The local cafe doesn't ask a business broker for a minute-by-minute valuation. The local builder doesn't sell his company three months after he bought it, because someone told him the next six months might be tough.

Invest for the long term

A picture paints 1,000 words. Vanguard’s 30-year index chart is an extraordinary reminder of why fretting over the short term is not a great way to invest.

Over 30 years, a hypothetical $10,000 investment in the ASX's All Ordinaries index compounded to more than $130,000. All you had to do was...nothing. Literally nothing. Why would you put that at risk trying to day-trade or time the market?

My approach? Buy quality businesses at good prices. Then let time do the work.

Wrapping up

Buying shares is one thing, but selling might just be the hardest part of investing. No one knows what's coming next, and your emotions will beat you up if you let them. You should have sold Company X earlier. You should have held onto Company Y longer. It’ll drive you mad...if you let it.

I overcome that by taking a long-term view. ‘I think Company Z can grow at good rates for 5-10 years or more’ is my favourite type of investment. Because when you frame it that way, you're telling yourself 'don't worry about what the market thinks in the meantime'. Focus on the horizon.

Learn more about hands-on investing on Sharesies.

Scott Phillips is not associated with Sharesies Australia Limited or its related companies. Views expressed by Scott Phillips are their views and do not necessarily represent the view of Sharesies. If any financial product or stock has been mentioned, you should obtain that product's disclosure documents prior to any decision whether to acquire the product. Information provided is general only and current at the time.