Buying shares is both exhilarating and frightening at the same time. It is frightening because you are putting your hard-earned money at stake, but it is also exciting because you know that if your investment is a good one, it could yield substantial profits. However if you want to make consistently profitable investments there are two questions you should always ask yourself.
Firstly when you find a company that you may be interested in investing in, you should pretend that you’re a billionaire and you’re actually taking over the company yourself. This is a tip I picked up from Robbie Burns, who is arguably one of the most successful investors in the UK.
It works a treat because what this does is it enables you to effectively value a company and therefore decide if it’s cheap enough to invest in at it’s current price. You can do this by first of all identifying the market capitalisation of the company and then looking at the net profits for the year (and projections for future years).
For example if the profits for the year are $50m and the market capitalisation is $500m then this is a solid investment because it would take just ten years to recoup your initial investment (and even less if you factor in any growth in profits). However if the market capitalisation is currently $1000m then it would take twenty years to recoup your investment which is obviously a lot less appealing from an investment point of view.
The general rule is to look for companies whose market capitalisation is less than 15 times net profits, although I personally prefer to seek out companies whose market capitalisation is less than 10 times net profits, particularly at the moment when share prices are low.
The second question you should ask yourself before investing in a company is whether you would be happy to hold on to shares in this company for the next ten years or so. You have to ask yourself whether profits (and dividends) will continue to grow in the coming years or will the company be overtaken by competitors. You ideally want to look at market-leading companies who are at the forefront of their industry and who have a long track record of increasing both earnings and dividends.
So to sum up, if you want to make profitable share purchases, then you won’t go far wrong by asking yourself these two key questions before investing in a particular company:
1. If I was a billionaire and money was no object, would I be prepared to take over the company based on it’s current market capitalisation?
2. Am I prepared to hold on to shares in this company for the next ten years or so?