Home Business Insights & Advice Why it’s vital to do your due diligence before investing

Why it’s vital to do your due diligence before investing

by John Saunders
17th Jun 21 9:46 am

Most people can relate to having that one friend who is always reaching out with the next big investment idea. They tell you about a company that is “massively undervalued” or “can’t lose,” and you simply have to get in now before it’s too late. Yet, no matter how much you trust your friend and how tempting it is to take what they are saying at face value, you must always do your own research before you jump headfirst into any investment like this.

You see, whenever you’re investing your hard-earned cash into a company, you must first carry out sufficient due diligence to confirm the facts, check the details, and make sure that YOU believe that the company is a good investment.

What is investment due diligence?

Due diligence in investing refers to the personal investigation you should carry out to see whether a particular financial instrument is suitable for you. In this case, the potential investor must assess the company/stock in question in order to ascertain its viability for future profits and ensure that everything is as it appears. The extent of your investigation is entirely dependent on your particular preferences and the level of risk you are willing to accept on any single investment.

Carrying out due diligence can include various measures such as examining the company’s long and short-term performance, taking stock of its financial records, and assessing its public perception and prospects. For most investors (both corporate and individual), this type of investigation should be used as a means to arrive at an objective decision as to whether or not to go forward with the investment. It also allows them to see what kind of results they can expect in the short and long term, so they can go into the situation with their eyes wide open.

Furthermore, not only should you do your homework on the company you’re investing in, but you should also make sure the broker service (and any other financial software) you’re utilizing is secure and reputable. Investimonials is a great place to get objective financial product reviews so you can improve your knowledge and make sure you’re always dealing with legitimate organizations..

Why is due diligence necessary?

Carrying out thorough research is essential whenever you invest your money into a financial instrument. However, it’s even more important when you do not fully understand the company you’re investing in.

You should never buy a stock only because you think its price will rise, as Warren Buffet loves to point out. Instead, you should put your money into companies that you understand and believe will provide long-term value. This is especially true when dealing with alternative investments, such as penny stocks, cryptocurrency, or any stock that isn’t a common household name. Now, that’s not to say that these are inherently bad investments; it’s just they require you to act more cautiously if you are to avoid losing your money.

Here are a few of the main benefits of carrying out due diligence on your stock picks:

  • You can set clear expectations. This allows you to set realistic price targets for your entry and exit points.
  • You have a better chance of avoiding scams.
  • It ensures the investment aligns with your goals and values.
  • You can protect yourself against heavy financial losses by only investing in companies with solid fundamentals.
  • You will be able to more accurately analyze and mitigate risk from a business or investment decision.

How to conduct due diligence before investing

When completing due diligence on a stock before investing, you should evaluate a variety of aspects, such as:

  • Company capitalization

The company’s market cap gives a clear demonstration of the company’s size by calculating the total dollar market value of its outstanding shares.

  • The business model

Do you understand the company’s business model? You should fully understand how the business makes money before you invest.

  • Revenue

When digging into the financials, it’s always good to start with the revenue, profit, and margin trends. It’s essential to check the company’s price fluctuations over time while looking at important metrics such as the price-to-sales (P/S) ratio and the price-to-earnings (P/E) ratio.

  • The overall health of the industry and competitors

With the previous information in hand, you can now assess how the company ranks among competitors in terms of quality, pricing, growth rate, cost structure, and market share. The relationship with their competitors somewhat defines most companies, so be sure you don’t skip this step.

  • Management and ownership

Evaluating company management is a crucial step when carrying out your due diligence. Understanding a company’s management quality and expertise is critical to predicting future success and profitability.

  • The balance sheet

Does the company have any outstanding short- or long-term debt? If so, when were these debts incurred, and will they be an issue moving forward? Compare their debt-to-equity ratios with their competitors to see if their levels are reasonable.

  • Stock price history

Before you invest, it’s important to understand the recent price history of the stock in question. Has it been relatively steady for a long time, or has it been volatile and subject to extreme price movements? These steps help you to understand what you are in for if you do decide to invest.

  • Other risks

Finally, try to think if there are any apparent risks that you forgot to take into account. Are there unresolved legal matters that could be problematic? Are some of their key patents expiring? Maybe the company is in trouble with regulators or has been fined for breaking the rules recently. All of this is valuable knowledge that will help you arrive at a more educated conclusion.

Final word

Truth be told, tips can sometimes pay off (depending on the source’s reliability). Nonetheless, the long-term success of any investment strategy is contingent on your ability and willingness to carry out thorough research before entering into any new positions, even if the person giving you the tip claims to be the next Bill Ackman!

The fact of the matter is, no matter who handed you a stock suggestion, you should never believe it wholeheartedly and accept it without any skepticism. You should always conduct your own research on a company before investing your hard-earned money. This way you can ensure that it is worthy of your investment and that you fully understand what to expect from it.

 

The above information does not constitute any form of advice or recommendation by London Loves Business and is not intended to be relied upon by users in making (or refraining from making) any investment decisions. Appropriate independent advice should be obtained before making any such decision.

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