Ask These Questions Before You Buy Any Stock

This is the eighth of ten articles in the Filthy Rich Animal Investing Basics Series.

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Whether you’re conscious of it or not, you’re continuously weighing price and value when making decisions.

I bought a house in early 2024. Some of you know the drill: You look online, you identify neighborhoods that seem like a good fit, then narrow it down to the houses you like. Well, there sure are a lot of houses in decent neighborhoods, which, to put it charitably, need a little TLC.

Some of those homes may even be good bargains! But what they're actually worth depends on how willing an owner is to make the repairs needed for the house to be a place that people want to live in. Those renovations typically bring their value more in line with comparable homes in the ares.

You see where this is going: When you're investing in stocks, you have to be sure that a so-called “good company” is also a good investment.

But here are two questions to ask before you smash the "buy" button. 

Is This a Good Company?

What exactly makes a company “good” in the context of investing?

Here are a few criteria.

• Strong growth prospects: Palantir is a prominent company that’s an example of one where analysts see sales and earnings growing at a fast pace in the coming quarters.

• Solid product portfolio. Eli Lilly has grown sales and earnings on the strength of its obesity and diabetes treatments. Recent studies indicate even more promising results.

• Ability to handle debt. Intuitive Surgical, the fast-growing maker of robotic surgical systems, reported no debt for the fiscal quarter ending in September 2024. At the end of 2023, the company had $7.34 billion in cash, cash equivalents, and investments.

Is This a Good Stock?

The stocks of those three companies have performed well and their outlooks are promising. But the criteria for evaluating a good stock aren’t the same as for identifying a good company.

Here are some factors that make a stock “good.”

• Valuation: Procter & Gamble trades at a forward P/E (Current Price / Next 4 Quarters' Earnings) ratio of approximately 24x, below its industry average of 26x. This stock offers a dividend yield of around 2.4%, backed by 69 consecutive years of dividend growth. This combination of reasonable valuation metrics and reliable dividends highlights the value investors receive for the price.

• Investor Sentiment: Tesla has shown strong investor sentiment, with a notable uptrend in price and high upside trading volume. Recent technical analysis shows Tesla consistently bouncing off support levels, reflecting positive momentum. Despite being richly valued, the bullish sentiment has driven significant price gains.

• Portfolio Fit: Does it add diversification or bring other qualities that help grow my wealth? The best stock in the world is no good if it doesn’t make my portfolio better than it is without that security.

A Trip to the Supermarket

OK, we all know that broccoli is good for us. We may crave Trader Joe’s chocolate pretzels (a completely random example, I promise), but we also know there’s more downside to eating more of those compared with just adding a little bit of broccoli to our diets.

In this admittedly silly example, broccoli is the “good company.” Chock full of vitamins and minerals and all kinds of healthy stuff that a nutritionist can tell you all about.

The price of broccoli crowns at Wegman’s is about $0.77 a pound. I know this because I just checked. That seems like a pretty good deal, and you decide to throw some in the shopping cart.

But say the price of broccoli has run up to something crazy like $3 a pound because everybody just loves broccoli, and doesn’t want to miss out on a good thing. (Yes, I’m making a not-so-veiled comparison to Nvidia (NVDA) here.)

Broccoli is still good and good for you, but at that price, you decide to substitute another vegetable for tonight’s dinner. Cauliflower is pretty similar, and it’s selling for just $1 a pound, so go crazy with that.

Cauliflower is also a “good vegetable,” loaded with healthy stuff. In terms of its valuation, it makes more sense at this hypothetical moment.

But don’t forget: It’s not the only grocery item that could make a good addition to a balanced dinner plate. Head on over to the meat department - or the tofu department if meat isn’t your thing - and start looking at the prices of chicken.

See how that works?

A good investment should be of high quality. And the shares of stock that I buy should be reasonably priced.

Good company, good stock.