The Best Way to Buy Stocks Without Risk!

Everyone loves the idea of tossing in their job, laying on a beach planning their next holiday. Spending the rest of their days enjoying their life doing what they want to do when they want to do it.

However, you need money to have the ideal lifestyle that suits you, right?

Wouldn’t it be nice, to get that money, if all you had to do was read the news paper each day, spend an hour on the internet doing a bit of research and then make a phone call or two. Then that’s the day’s work done. It’s probably all over by 10.30am…… so you can go off to the beach!

Well, there is a job that will allow you to have this lifestyle……. Sort of.

The job is that of a stock market “player”. But the problem with this job is it involves a degree of risk and sometimes failure. Of course the “upside” is substantial and it can afford you a great life.

To get started on this new life, you need a couple of things.

The first is capital. You can’t trade shares without money….. And I would suggest you don’t start borrowing against your house, this is unwise when you are starting off as you will make mistakes. Things can go wrong and the last thing you want to do is put your home in financial peril. No, you have to use savings. So, if you don’t have any money forget about this for the time being…… but don’t forget this opportunity will be there when you are ready.

The second this you need is knowledge and reliable information. That is what I’m going to discuss right here.

There are some fundamentals you should look for in any share you invest in, and this applies to long term purchases or “trading” purchases.

1. Look for consistent earnings.

Seeing that a company can produce solid consistent profits is all important. Now, I know that in some newer companies (where quite often there are great opportunities) there may not be a long term history of good profits, simply because there is no long term history…. So extra caution should be used here. I’m not saying you shouldn’t buy the shares but the chances of something going wrong increase. Never get involved with a company that has dropping earnings or has very erratic earnings. These are the companies that could all of a sudden go “belly up”.

2. Look for growth.

Without growth of sales and earnings, there is no point in investing in this company. The only reason a share price goes up, is because the earning have increased or the market believes they are going to increase.

3. Low levels of Debt

One of the main things that send companies to the wall is Debt. Too much debt in the balance sheet and the company could be in a weak position if interest rate levels were to rise. The thing to look for is having net “cash” in the balance sheet. Do this little exercise. Add up all the cash and cash equivalents (like investments), then subtract the long term debt. Do they have a net positive cash position, or is it negative? If it negative, this is a bad thing and maybe you should think about a different company to invest in.

4. Dividends   

There are two ways to look at dividends. Companies that pay high levels of dividends, for instance more than 60% of their net profit are good from the point of view that “income seekers” like their shares and will continue to remain invested with them for the dividends, and this is good thing. On the other hand, this could also be a bad thing. The reason is, if they are paying out most of their profit to share holders, what are they “building” the business with? What remains? With only a small proportion of profits being re-invested into the business, you can imagine that the business is not growing quickly. If it doesn’t grow and increase earnings, then the chances are it’s share price won’t grow either. This is bad thing.

A company that only pays out a small dividend in terms of percentage of profit, is probably better from the point of view that they are building the business out of their profits and therefore the chances are the profits will also grow and so will the share price.

Whatever a company does with it’s dividends, one thing is very important, that they are consistent and not erratic and that the dividend in always growing, not in terms of percentage paid out, but in simple dollar terms. You just need to see the profits growing….. Nothing else matters!

5. High levels of Inventories

This can be of great concern. It means the company may have purchased too much of something that is not selling, which means at some time in the future, they are going to have to write it off or sell it as a discount. This is not conducive to good earnings and share price growth. Check the balance sheet over a few years and if you see an increase in inventories that is higher (in percentage term) than the growth in sales….. A problem is looming, beware!

6. A Price Earnings Ratio too High

If a PE ratio is too high, it may indicate one of two things. The first is that this is  “hot stock” and everybody is buying it because one day it will be worth the price paid……. This is rarely ever the case. The second reason is this is a company that due to it’s “spotless” record and good financial health attracts a premium to the market. You simply have to pay more for a quality stock. This is a company you probably should own, but the price is too expensive. So what is a high PE ratio? Well, I personally think anything over 30 is too high. At a PE of 30, the company is currently returning 3% to the share holder. Or in other words, for every $ 30 you put in you get $ 1 back. Not a very impressive return. The only reason you would ever consider a share like this, is if it’s profits were growing consistently at over 20%+ pa. Under no other circumstances would you place money out at 3% with a growth factor of less than 0.6% per year… what are you crazy?

A good PE for the right company, with all the right attributes is under 20. If it stacks up well and you buy it for the right price, you’re on to a winner for sure.

7. Little Competition

Industries that offer little competition do best, for one simple reason, they don’t have price wars.  Sure some industries do OK with lot’s of competition, like banking, but I sometimes wonder about competition there, I sometimes think they don’t compete, but “arrange” for a “suitable outcome” for all parties. Why doesn’t one bank break away and offer no fees on any account and completely annihilate the competition? Because they have agreed to keep things just as they are….. Cynical viewpoint, true, but who disagrees with me? Anyway back to competition. Companies that have  a market niche all to themselves obviously do well and this is something to look for.

8. It’s involved in a business that makes sense.

This was always one of the pre-requisites of Warren Buffett. He would never invest in something he didn't understand and nor should you. Would you by a business that didn’t make sense? Of course not, so you shouldn’t invest in one that doesn’t make sense.

For instance, the product or service it provides…. Do you use it? Is it a “necessary” of life? Is the product one of those things people can’t do without? If the answer is yes to these questions, then this is a company you should consider investing as long as all the other fundamentals stack up.

9. Is the company ever involved in “Buy Backs”?

Does the company or has the company recently bought back it’s own shares? If it has this is a good sign. This basically means the directors are “backing themselves”.

This is very important. If a director of a company is investing his money in ANZ and he works for NAB, what does this tell you? A very good sign that a company is going forward is when the directors are buying shares in the company. You can find this out by reading the Financial Review or Wall St Journal (for US shares), checking various sites of the Internet, or by checking the Annual Reports of the company in question. Quite often these reports are available at the company's website or you can ring their head office and get one sent to you.

The Annual Report will prove useful for checking  most of the 10 fundamentals I have been discussing, so make sure you read one before you invest.

The reality is you may look at 20 companies and not one will meet the criteria as laid down in the 10 fundamentals…….. You may think this has been a waste of time doing all the due diligence only to find they have failed in a few different areas. You may be tempted to buy the shares anyway, and that’s ok, but please understand it doesn’t mean you won’t make money, it simply means you have reduced your chances or increased your risk, that’s all.

By sticking to the 10 fundamentals, the chances of you winning in the stock market and being able to have that ideal lifestyle have increased and the chances of you losing money have been reduced by a similar proportion.

The Australian Share Market Guide Includes The Ultimate Stock Picking Method that will Guarantee Stock Picking Success with at least a 90% success rate. Click Here for Details