Investing is the key to building wealth, but all investments carry some degree of risk. So how do you know whether the risk is worth taking? These are some of the key indicators of a good investment.
The Company’s Information Is Positive and Accessible
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Carefully research any company you plan on investing in. It should be easy to find information about businesses you’re interested in. A lack of transparency can indicate that a business has something to hide and could be a bad investment. The most credible companies publish annual reports which contain much of the information investors need.
There are several key indicators for positive performance, including excess economic profits, strong sales figures, a short cash conversion cycle, positive fixed asset turnover ratios for its industry, and a high return on assets ratio.
The Company Has a Good Track Record
Past performance is one of the strongest indicators of future performance. While current performance matters, companies with good track records are typically good investments. Financial experts suggest reviewing a company’s performance over at least 10 years. Again, annual reports are your most valuable resource here. Evaluate a range of metrics to accurately assess a company’s long-term performance.
Look for businesses that have increased their earnings per share, net sales, and book value per share by at least 12 percent annually. Return on capital employed should be greater than 13 percent annually and the wealth creation index should always stay positive. Companies should also have a debt-to-operating cash flow of three or less, meaning they take no more than three years to repay their debts.
Remember that you’re looking for consistency here. While exceptional performance in any given year is impressive, you still won’t want to invest if the company’s performance is usually below par.
The Company’s Industry Is Strong
No company performs in a vacuum. While assessing individual companies is important, you should also look at the big picture and current industry trends. Think of the stock market like the real estate market. Just as you wouldn’t buy a home in a bad neighborhood, you won’t put your money into a failing sector. Growing industries are best for investing. If investors are already making money in the sector, there’s a strong chance you can, too.
Take the marijuana sector, for example, which is locally worth approximately $52.5 billion. Legal marijuana sales should double this year compared to 2018. Stocks on the U.S. Marijuana Index gained more than 71 percent between June 2017 and June 2018. Some of the best marijuana stocks, like Aphria and Hydropothecary Corporation, posted triple-figure growth. As more U.S. states legalize marijuana, the industry should grow. Some predict that it will surpass the beer industry, which has a current value of $110 billion. With such positive trends within its sector, investing in marijuana companies makes good sense.
Looking before leaping is one of the best ways to make smart investments. Analyze each investment you make and review it regularly to make good investment decisions now and in the long term.