5 questions you must ask yourself before buying any stock

Investing isn’t easy. That’s why advisers, fund managers and investment bankers get paid the big bucks.

However it also doesn’t have to be as hard as what many make it out to be. There are a few simple rules that you can follow to make yourself the best fund manager you’ll ever employ.

Benjamin Franklin, once said “An investment in knowledge pays the best interest” and it’s easy to see why. If you put the time and effort into anything, your costs will be lower and the ability to create and repeat your own successful investment strategy is something you can keep for a lifetime.

It all comes down to preparation and learning. Let’s use the example of ANZ (ASX: ANZ) as a case study.

What does the company do?

Stocks, contrary to popular belief, aren’t just 3 letters that go up or down. Tickers (the stock symbol) are just a unique code attached to a company that you will, or won’t, buy. Peter Lynch, one of the most successful fund managers in recent history, was famous for his investing methodology, “Invest in what you know.” This is, by far, the most important question you need to ask yourself.

ANZ prides itself on being a major bank both in Australia and New Zealand. Of the biggest Australian banks, it controls the smallest amount of the mortgage market and in recent years has invested heavily in its international division. It offers retail, business and corporate banking services.

What do you like about it?

As investors, were banking on the future. Not the past. It’s vital we know what the company is trying to achieve and not so much what it has achieved. Pipe dreams don’t count. It’s important the company’s goals are rational and can be sustained. Ben Graham said, “The individual investor should act consistently as an investor and not as a speculator.” – In other words make sure you’re not buying a company on a whim.

ANZ’s Asian strategy looks promising, it has grown revenues strongly since 2007 although its margins are narrow and competition is strong throughout Asia. Although its target to derive 25%-30% of earnings from its APEA division appears to be a tall order, the diversified earnings and long term strategy will differentiate it from its Australian rivals.

Who is managing my money?

Investors often forget this one but it’s extremely important. When you invest your money, you’re essentially saying to the company’s directors, “Here. Take my money. I believe you’ll do make more with it than I otherwise would by myself.” If you’re giving your money to someone else, it’s important you know who they are, what they have done and their likelihood to take the company in a positive direction.

The head of ANZ bank is Mike Smith. Mr Smith is one of the most sort after bankers in the world and has recently rejected offers from larger banks to become their leader. However in a few years it looks likely that Mr Smith will be replaced by an internal director with experience in Asian markets.

Is this the best price to buy in?

Phillip Fisher believed, “The stock market is filled with individuals who know the price of everything, but the value of nothing.” So many people will buy a stock when its “hot” but touching something hot will get you burnt. When you buy a stock it’s important you identify facts, not fiction and that comes by looking at things objectively.

Believing house prices can continue to go up whilst unemployment and interest rates stay low (fuelling a rush on demand) is naïve. We’ve become accustomed to rising house prices and strong GDP growth. This has pushed bank stocks too high in my opinion and at current prices they are not the cheapest they’ll ever be. Economies are cyclical and so are stock markets.

What is your investment timeframe and risk?

“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, you’re not ready, you won’t do well in the market” – Peter Lynch.

Managing risk isn’t about the size of the company or its level of debt. It’s about asking yourself questions, challenging your opinions and making informed and sensible decisions. If your company has good balance sheets (could they afford to stay alive in a recession?), sound management and you bought the stock at a GREAT price (not just a good price) then you’ve done everything you can to mitigate your potential for loss. However it’s also important to ask yourself how long you’d want to invest and how often you’ll reassess and rebalance your portfolio.

ANZ is in a sound financial position. Compared to NAB (ASX: NAB), ANZ has a stronger tier-1 capital ratio and its ambition to diversify earnings should help it leverage any domestic economic cycle with its businesses abroad. Up until 6 months ago, ANZ made up a big portion of my portfolio but I reassessed my weightings and believed my money would be better spent elsewhere. It’s important to do this frequently, but not too often.

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies. 

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