What does the company do?
Companies and groups
Just as stocks and shares have become synonymous, so too the terms company and group have become interchangeable.
Strictly speaking, a company is one single business entity while a group is a group of companies all under the same ownership.
In a group, there will be a parent company that owns the various parts of the empire, which are the subsidiary companies kept separate for administrative convenience because they are into different lines of business or they operate in different countries.
Sometimes the parent company produces goods and services as well. In some cases the parent company does little itself and simply exists as the umbrella under which the subsidiaries operate. In that case the parent is a holding company and the subsidiaries are operating companies.
A company concentrating on just one line of products or services may not need to split itself into different units, but if it does do so it will form divisions, with the head of each division reporting to the one chief executive.
Dividing groups or companies in this way means it is easier to see which part of the operations is doing well and to spot problems as they arise.
What a company does
You need to have a good idea of what a company actually does before you invest in it. You wouldn’t buy a tin off the supermarket shelf without knowing what was inside it, would you?
Some companies compete head on with others producing the same range of products or services; others try to find a niche market, concentrating on just one product where they are the biggest or only player.
Some companies believe in having a wide spread of products so that if demand falls off for one they have other lines to fall back on; while some specialise so that they know their business inside out (a tactic referred to as sticking to their knitting).
Some concentrate on the UK, or even just one region; others want to go out and conquer the world.
Assessing a company
How to assess a company
Having established what the company does, you should consider whether it is expanding. Are sales rising or falling? While turnover is less important than profits, a company that is selling less and less is not going to survive long unless it can stabilise its income.
Is the company a heavy user of energy or fuel? It is likely to be suffering from higher costs unless it is able to pass those costs on in increased prices to its own customers.
Another important consideration is the extent to which the company has fixed costs, such as offices and factory production lines. If sales go up and costs remain fairly static, profits will automatically rise. However, if sales fall and costs cannot be cut, the effect on profits can be pretty dramatic.
The importance of management
No one tactic guarantees success or is doomed to failure. You are looking for companies that demonstrate that they know what they are doing, whatever it is. Good management counts for a great deal.
So you want to know if top executives have changed recently. A poorly performing company can be turned round by new management who have fresh ideas and are determined to prove a point. A great company can tail off when the driving forces retire.
Really well-run companies plan for the succession. They avoid having the two top men, the chairman and the chief executive, retire at the same time. They set the search for a successor rolling in good time. Finding a high-quality candidate for a top job can take months of searching by expensive recruitment firms popularly known as headhunters.
So management matters. But so does what the company does. Some sectors such as housebuilding have been expanding for years, thanks in part to low stable interest rates, while shops have struggled to cope with intense competition in the high street and with the incursions of online retailers.
Where to find information on a company
Ascertaining this information may seem daunting but you should try to build up as accurate a picture of a prospective investment as you can before committing your cash. It is not as difficult as you think.
Listed companies maintain websites with up-to-date information on what the company does, its financial performance, who the directors are and a host of other facts. From August 2007, AIM companies have been obliged to maintain a website with key information. Start using your internet search engine!
The website will also contain press releases and any trading statements the company has issued, as well as copies of the annual report and the most recent company results. These give you a picture of how the directors assess the company’s performance over the past year and the outlook for the coming months.
Do read any such pronouncements with a critical eye, though. The directors may be putting the best gloss on a difficult situation. If they have delivered on promises in the past they are more likely to do so in the future. Repeated broken promises are a warning sign and you should be loath to take mere platitudes at face value.
It is true that past performance is no guarantee that there will be more of the same in the future. However, past performance is the most accurate guide you have got.
Which companies to invest in
Do not invest in companies you do not understand. For example, if a company develops drugs and you cannot grasp the basics of Phase I, II and III trials – not many people do – then avoid the sector until you can. If you want to invest in insurance brokers and reinsurance companies, you had better find out what Lloyd’s of London is all about.
Nor should you go to the other extreme and invest only in the sector you happen to work in on the grounds that that is all you understand. Portfolios should be balanced with one stock in each of a range of, say, ten sectors to give you a fair cross section.
If you bought shares in HSBC, Royal Bank of Scotland, Barclays, Lloyds TSB, Northern Rock and HBoS in the early years of the millennium, and nothing else, you were up the creek when banking shares went into a dive in 2008. The banks may have been too big for the government to allow them to fail but four of the six in that list were not too big to fail their shareholders.
The notion of investing only in ethical companies has become trendy in recent years. By all means follow your conscience – but bear in mind there is hardly any company in existence that you can’t find some objection to. Placing any kind of restriction on which shares you buy can limit your opportunity to make money. You can restrict yourself to ethical investments and succeed; it is just more difficult.