Don't buy that share until you've read this.
Do you know every time you buy a share exactly why you're buying it, what your criteria are, how it fits with your overall investing profile, and when you'll be likely to sell?
No, nor do I. So I decided it's high time I did something about it.
The problem is that when times are good, as they have been for the last six weeks or so, it's all too easy to get a rush of blood and buy on a whim. Don't do it. Alternatively, perhaps some soothsayer pops up on Bloomberg TV saying "sell the market, it's going to do nothing for the next decade" and you turn bearish all of a sudden? Ignore all this.
Focus
It's useful to temper your views against the general macro-economic backdrop, but broadly speaking, it's far more advisable to concentrate on company-specific news.
You should know how much is sensible for you to invest in shares given your other commitments in life. And within that allocation, you should decide how risk-seeking or risk-averse you want to be. But the experience of the last 18 months has shown us that being risk-averse doesn't necessarily mean buying blue-chips. Many much smaller stocks, often in exciting industries, can actually be quite defensive due to their cash and asset backing.
Once you've decided on the allocation of your investment cash, it's time to do your research. So you've found something you're feeling good about, you've done all the research you can and you're ready to buy? Well stop there for a minute and have a look at your last-minute share reminder list. What!? You haven't got one? Sadly, my portfolio is littered with dribs and drabs of shares that looked ready to rocket a few years ago due to reasons I can't even remember now -- but of course, they're a fraction of their former value. We all make investing mistakes, and we'll all continue to make them; c'est la vie. But if I'd always used a rigorous investment checklist, there wouldn't have been half as many.
The personal tick list
The problem is that human beings are inconsistent creatures. We all have mood swings. Sometimes you're feeling over-confident, maybe even a little cavalier. The next month, all is doom and gloom. The best way I know of to combat this is via a "before you buy" checklist.
Each investor's list will be different from the next depending on the degree of risk and a host of other factors. Devising your own is best, but here are a few questions I like to be able to put an emphatic "YES" to before buying:
- Have you truly done enough research? If so, would you do a "Warren Buffett" and buy the whole business if you could afford it?
- Does the company have a robust balance sheet and plenty of cash?
- Does it have a good dividend yield that is adequately covered by earnings?
- Does it have good quality earnings (the best companies are those that have very little need for capital)? If earnings seem too good to be true, they probably are. Just ask former Enron shareholders.
- Do you truly understand exactly how the company makes its profits and what it does?
- Do the directors hold a reasonable (but not controlling …) stake and/or have they been buying shares?
- Are the directors paid reasonable salaries and/or bonuses?
- Does the management demonstrate realistic objectivity about the company's prospects?
- Has the current management demonstrated honesty in all its previous statements?
If in doubt -– leave it out
Try not to make the mistake of "making" a potential investment fit your criteria. Most of us have made the mistake of deciding to buy before looking at the detail.
Once you've devised your own checklist, make sure you use it -- in the best of times and in the worst of times. Alternatively, drip-feed money into your favourites via The Motley Fool's Share Dealing service. And have an accurate idea of what price you're expecting to sell at.
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