- Due diligence is important before investing in any business or stock.
- Other important factors to consider include CEO and management team, board of directors, competition, brand integrity, regulatory environment, taxes, and incentives.
- Also, consider the ownership structure, employee welfare, manpower development, technology, micro and macro-economic activity, and political stability.
Chris was offered an opportunity to be a part owner of a cyber café with his uncle who decided it was time to retire and move back to his village. The purchase price was agreed upon between both parties and Chris had also taken stock of the assets that he will soon be taking over.
However, Chris wasn’t still done with his due diligence. Even though he knew the business has been in existence for years and had appeared profitable he still felt he needed much more.
Investing in shares should follow the same approach. Beyond just relying on fundamental and technical analysis, a lot more due diligence must be carried out before you decide to invest in shares. These are examples;
CEO & Management Team
Warren Buffet was once quoted as saying he invests in companies that can be run by a stupid person because one day a stupid person will run that company. The operations of any company are carried out by a management team led by its Managing Director/CEO.
A CEO is one of the most important criteria any investor must consider before investing. You should make an effort to know who is running the business, their vision, antecedents and charisma before deciding to invest. It’s the same thing you would do if you were to vote for a president so why not do the same for a company you hope to be a part owner of? Most failed businesses or bad investments have often been a result of bad leadership. A great company is always represented by a great leader.
Board of directors
The Board of Directors of any company are bestowed with the responsibility of overseeing the business activities of the company on behalf of its shareholders. This puts them squarely at the helm of affairs in any company. A weak board is a sign that the management of the company can get away with anything it wants which more often than not is not in the best interest of shareholders.
An irresponsible board of directors can be inimical to your investments in many ways which is why you must make efforts to identify who the members of the board of directors are. You should also search online for news related to their activities and pronouncement in the past. These are clues to how they have managed the business and indications of how they will continue to manage the business.
Competition
Before investing in companies you must ascertain where they stand against their competition. Is the business in a highly competitive environment? What is the barrier to entry and how strong is the company’s brand? These are all important factors you must consider before giving your stockbroker your money. For example, Companies in highly competitive industries are most susceptible to low margins and low profitability.
Therefore, if you invest in a company that gets easily outdone by the competition, the company loses market share and then profits leading to a diminution of your investments. Companies in industries that have a high barrier to entry may often appear to be uncompetitive and good for investment.
However, that on its own does not determine viability. Such industries may also be so capital-intensive it will take years for them to break even making it unattractive for others to join. Whatever the case is, companies that constantly beat competition year after year and possess superior products are better investments than others who aren’t.
Brand Integrity
You must also identify the brand power of the company and its image amongst its consumers. Businesses that are easily recognizable and known to all find it easier to sell products and see competition even in downturns. Companies with strong brand power can also effectively control price which is a very important factor in maintaining market share and guaranteeing growth. A company that can increase the price of its products or services without much fear of losing its customers to the competition is likely an attractive buy for most value investors.
Regulatory Environment
Recently, the Central Bank of Nigeria twice increased the cash reserve requirement of the bank’s public sector deposits. This sent shock waves down the spines of the banking sector leading the banking index to plunge 18% year to date in 2014. These are examples of regulatory pronouncements that can affect industries.
It is, therefore, important for you as an investor to understand the regulatory idiosyncrasies affecting an industry/company before making that investment decision. Information such as the law guiding the industry as well as its regulatory framework, the official in charge and penalties for breaches are examples of what you must know.
Taxes and Incentives
The difference between the profitability of two companies can often be how efficient their tax structure is. For example, Dangote Cement has posted over N400 billion in profits in the past three years but has not paid any corporate tax because it is a designated pioneer company. Whilst this may not be an automatic advantage, it is still a strong indicator of where and when to invest. Incentives that minimize tax, duties and levies, create extra cash flow which companies can put to better use to maximize shareholder value.
Other factors to consider are Ownership structure employee welfare and manpower development, technology, micro and macro-economic activity and political stability.
Editor’s Note: This article first appeared on Nairametrics in April 2014 and was republished due to its relevance.