It’s impossible to get everything right with investing. We simply don’t know what share prices will do in the short-term, medium-term or long-term.
But, there are a number of things we can look out for. The purchase price of the shares you buy is a big factor for your investment returns.
That’s why I think some of the below points are important to think about:
Is the business cyclical?
Some people just think of all shares with the same type of risk. However, some businesses are cyclical – even if they haven’t necessarily gone through a bad point of that cycle for a while, or ever whilst on the ASX.
Financial businesses like banks such as Westpac Banking Corp (ASX: WBC) are cyclical, even if takes 10 or 30 years for that cycle to end.
Commodity businesses are likely cyclical, whether it’s resources such as BHP Group Ltd (ASX: BHP) or perhaps agriculture like Select Harvests Limited (ASX: SHV).
I think it’s important to recognise which businesses are cyclical so you’re not buying at the top of the cycle for the wrong price.
Does it have too much debt on its balance sheet?
Debt is useful for a business’ expansion up to a point. However, a large amount of debt can be too much for a business to handle, particularly if it leads to a business getting close to (or breaking) its lending covenants.
There have been many cases of businesses falling foul of debt in recent times. It can cause them to have to sell off assets, perhaps their most valuable business units.
In a perfect world we might only choose investments that are debt free. But it could be wise to expand the investment universe and mostly consider shares that have more cash than debt. Two of my favourite shares have zero debt on their balance sheets: Altium Limited (ASX: ALU) and Washington H. Soul Pattinson and Co. Ltd (ASX: SOL).
Will a tailwind lead to growing profit margins?
A tailwind does not necessarily lead to growing profits, even if it leads to growing revenue. Companies like Healthscope and Japara Healthcare Ltd (ASX: JHC) both have a growing elderly population going for them, but as we’ve seen there can be a variety of factors such as the government, competition or regulation that causes the thesis and profit growth to become unstuck.
I think it’s important to always keep learning with investing. There’s no magical approach and over time you will hopefully find what works best for you.
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Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Altium. The Motley Fool Australia owns shares of and has recommended Washington H. Soul Pattinson and Company Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.