Step 4 Discovery

One mistake that many global investors make is buying the stock of a company without researching it first. This may seem like an obvious step that any investor would need to take, however this can be difficult when buying stocks internationally. The language barrier, and possible lack of information can prove challenging and some people choose to skip this step altogether. Because of this, it is a good idea to revisit the importance of due diligence.

Analyzing a company’s future prospects does not need to be too complicated. Most things an investor needs to know about a company’s performance can be found by simply evaluating management, the products that the company sells, as well as a few key numbers and ratios that can be found in any language.

Many of the world’s most successful investors will tell you that good management and a simple business model are the most important indicators of how well a company will perform in the long-term. Warren Buffett, for example, has made much of his fortune by investing in companies such as Coca-Cola and Wal-Mart. These companies are in businesses (selling beverages, operating supermarkets) that anyone could understand, appeal to the mass market, and have competent management.

“Never invest in a business you can’t understand.” – Warren Buffett

Beyond the qualitative, there are certain ratios that will show an overview of the company’s valuation and trends. Two of the most important are the company’s Price to Earnings (P/E) Ratio and Return on Assets (ROA). Of course, numbers are still written the same in most languages, so this can be a way of analyzing a company without needing to learn the language of the country you are investing in.

The P/E ratio does exactly what it says. It shows the price per share of the company, divided by the annual earnings per share of the company. With all other things being equal, a lower P/E is a better buy than a high one because the company will have high earnings compared to the price of their stock.

ROA shows how profitable a company is compared to their total assets. Here, the trend over the past several years, and the percentage when compared to competitors are more important than the number itself. If a company’s ROA is moving lower throughout the years, or is low when compared to its competitors, it shows that the company is less profitable than it should be.

In general, a company with good management, a low P/E and a reasonable ROA could be considered a good investment. But of course, things are always more complicated. The stock market can perform in strange ways that no amount of analysis could predict. This is even truer in smaller and less developed markets, where stock prices can move at the whim of important people and local phenomena.

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