How to choose a company to invest in
So you’ve decided to invest in companies. Great! But now what? Here’s the good news: investing in companies is really not that different from investing in anything else.
It’s about choosing things that give you a shot at the returns you want, in the time horizon you want, while taking risk you’re comfortable with. Here are some tips to help you choose which companies to invest in.
Step 1: Understand how you might make money
Investing in companies tends to give two different kinds of returns:
Income, when companies give shareholders dividends (a share of the profits), or
Capital gain, when shareholders sell their shares for more than they paid for them.
This isn’t an either/or situation—rather, it’s a spectrum. Some companies give a large portion of their profits back to their shareholders, and invest just a little bit in growth, while other companies invest more in future growth, and don’t give as much back to shareholders as dividends.
This is one thing you should think about before you start investing. If you don’t have a preference, that’s okay! You can just invest in a few different companies based on other criteria.
Step 2: Looking at the rest of your portfolio
Once you invest in companies, they become part of your investment portfolio—just like any existing investments you may have. This means you should think about what the rest of your portfolio looks like at the moment, and how that would change once you add some investments in companies.
If you’re looking to diversify away from the rest of your portfolio, you might invest 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 a bit more risk compared to the rest of your portfolio, or you might want to take a bit less. The direction you choose is up to you, but it’s important to think about the rest of your investments when you’re looking at individual companies to invest in. After all, all your investments work together to help you achieve your goals, so you should think about everything as one package.
Step 3: 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, if you look at how a company has performed over time, you can get a bit of an idea of what to expect. 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. But the second company is more likely to have a big move in either direction than the first company. You can’t predict an exact price, but you can get a decent idea of how volatile a company’s share price is. This is important for assessing how risky a company is—in general, companies with more volatile share prices tend to be higher risk, but also give you a shot at higher returns.
You can also 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.
Step 4: 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’ll 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.
Step 5: How do companies make you feel?
Now that you’ve narrowed it down a bit, do you recognise any names? For example, are there companies that you really support, and want to see thrive in the future? Are there companies with an ethical approach that really matches your values? Is there a company 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 are worth thinking about, because investing isn’t just about dollars and cents. It’s also about supporting companies that you want to see succeed in the future.
This last step may well be the most important. Investing in companies is 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 step—it’s 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. It comes down to looking at your risk tolerance, your goals, your time horizon and your values. So have a think about these things, and get started!
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.