We’ve broken down the process into four simple steps to help you get started.
Investing in individual companies isn't right for everyone – it's higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you're investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.
Step 1: Stay up to date
This is the most important part of the process. You should read through company updates on websites like that of the London Stock Exchange, watch daily news briefings and sign up to email alerts from companies themselves.
You don’t have to know everything. It would be impossible to read every piece of news, even on a slow day. Instead, focus on the industries, companies and markets you’re personally interested in.
Keeping up to date on political events around the world is also important as they can impact the way companies do business. Say, for example, the UK government decided to raise taxes on digital sales. This could make investing in an online retailer, whose costs will rise, a much riskier decision.
If you’d like to stay up to date with our latest views on investments, sign up for our ‘Share Research’ updates.
Step 2: Dig a bit deeper
This is an extension of step one – we can’t overemphasise the importance of being informed. Once you’ve researched the companies you’re interested in, it’s time to look further afield.
News at competitor companies, issues with suppliers of raw materials, and changing costs of alternative products are just a few examples of what to look out for.
Another key tip is to think whether the news would matter to you if you ran the business. If so, read up on it. It’s nearly impossible to do too much research and anything that could impact the way a business operates might be important.
Step 3: The nuts and bolts
Financials like revenue, profit and cash are all important to consider. But there are lots of things that impact a business, its dividend payments and its share price. Here are some of the key metrics to think about when researching a company:
- Operating Profit – profit is often referred to as the ‘bottom line’. Operating profit is slightly different from overall profit as it doesn’t take tax or interest payments into account. It’s calculated as the revenue from sales, minus the cost of operating the business. It’s a good way to show a business’s health as it takes into account all the things management can control in the short term.
- Operating margin – this is the percentage of revenue that makes it into operating profit. It’s calculated by dividing operating profit by revenue. It shows us how good a business is at turning sales into profit. Different types of business will have very different margin targets. In construction companies, 2% is a pretty good result. But software makers will typically be targeting 25% or even higher.
- Dividend yield – a dividend is money paid to shareholders from a company’s profits. The amount goes up and down over time. The yield is the percentage of the share price paid out in a year. It’s calculated by dividing annual dividends per share by the share price.
- Dividend cover – this shows how many times a firm could pay dividends from its profits. You can work out dividend cover by dividing the earnings per share by the dividend per share. A coverage ratio of 2.0 is usually considered a good level to support payments, but remember no dividend is ever guaranteed.
- Net debt/EBITDA – tells you about a company’s leverage. Leverage refers to the amount of borrowing a business has done compared to cash profits (EBITDA). If a company has very high debt compared to its cash profits, it could be at risk of defaulting on loans or being unable to fund necessary spending. For a more conservative investor, net debt of more than 2 times cash profits should be a warning sign, unless revenues are very reliable.
- Price to earnings (PE) ratio – this shows how much the market’s willing to pay per pound of profit. It helps to work out how highly the market values the company. A low PE ratio indicates the shares are out of favour and could be considered ‘cheap’ – although when things look cheap there’s usually a reason. You will want to compare PE ratios across companies within an industry, as well as with their long-term averages, to decide whether the valuation makes sense.
There are lots of different metrics that can impact whether or not you decide to invest in a company, and it’s important to consider the whole picture, not look at one or two in isolation. To learn more about how financial statements work and what to look out for, read our series on 'Understanding financial statements'.
Step 4: Choose your investments
Once you’re feeling confident with how the wider outlook for the company looks and the nitty gritty financials, you can start to think about actually investing. We try to clear out all the unnecessary facts from our writing, so it doesn’t get too complicated. You should try and do the same when making investment decisions.
Don’t forget to check in on your investments
It’s important to remember to check in on your investments from time-to-time to make sure they’re still right for you. There’s no hard-and-fast rule on how often you need to review your portfolio, but we think twice a year is sensible – once a year at the very least.
You should also check in when your circumstances or investment objectives change, or if there have been some big changes in the markets.
Hopefully this has given you some useful information that you can take away and apply to your own share research, as well as giving you a sneak peek into how we work. But if you’d rather we do some of the heavy lifting for you, sign up for our ‘Share Research’ updates. Remember though, there’s no substitute for your own research.
This article and our share research don’t give personal advice. If you're not sure if an investment is right for you, ask for advice. All investments can fall as well as rise in value, so you could get back less than you invest.