Where you invest your money is kind of a big deal. Choose right, and you can earn steady returns year after year, and maybe some dividends too. Choose wrong, and you could face heavy losses.
Ultimately, what you invest in is your call, but here are a few questions I always ask myself before investing in any stock.
1. How does the business make its money?
If I don't know how a business makes its money, I'll have a hard time determining if it will be successful over the long term. Passing on a stock for this reason doesn't mean it's a bad investment -- just that it's a bad one for me. Someone who is more familiar with the industry and the company will be able to read the signs better than I can to identify when a company's making smart moves and when it's making poor ones.
I choose to focus on companies I'm familiar with. I may not know about every product or service the company offers, but I want at least a general idea of how it makes most of its money.
2. Does it have a competitive advantage in the industry?
Many top companies have what Warren Buffett refers to as an "economic moat." This is a significant advantage it holds over its competitors that will help keep it at the forefront of the industry. When a company doesn't have an economic moat, there's a greater chance that it will struggle over the long term as it competes for clients with a growing base of competitors.
Examples of economic moats include lower pricing, unique products or services, brand recognition, or high switching costs that make people unwilling to leave their current brand or service provider for a competitor.
Economic moats are another reason it's important to know the company you're investing in. If you don't know anything about their business model, you probably won't be able to identify whether it has a strong economic moat.
3. How has it performed over time?
Past performance isn't an indicator of future performance, but it can still be useful to know. For example, if you're thinking about investing in a company but you see its share price has been declining over the last several years, that might be a sign it's not right for you. At the least, you should do some digging to understand what's caused the losses before you sink any money into it.
Or you might see a stock that's doing really well right now, but upon investigating its recent performance, you see that its value shot up virtually overnight after it gained a lot of attention on online message boards. This could be a sign that you're dealing with a meme stock. These usually aren't sound long-term investments, and there's a high probability that you could lose most or all of your investment once meme stock investors move on to something else.
You should look for companies that see steady long-term growth. All stocks have some ups and downs. But good investments trend upward over time.
4. What are the fees?
Fees eat into your investment returns, so you want to keep them as low as possible. Everyone should be familiar with what fees their broker charges and any costs associated with their specific investments as well.
Whenever possible, look for brokers that offer commission-free trading on stocks. This means you won't have to pay the broker a commission fee when you buy or sell a stock.
These may not be all the questions you want to ask yourself when buying a stock, but they give you a good starting point. Using this information, you should be able to rule out a lot of stocks that aren't worth your time and decide which are worth doing a deep dive into.