How To Know If It’s A “Good” Stock

Posted in   Investing   on  January 10, 2024 by  Money Bren0

Nothing in this article is financial advice. The writer is not your financial advisor. Investing contains risk and you can lose money. Consult your own professionals before making investment decisions. This article may contain affiliate links. 

Very often I have people ask me things like:

“Is Qantas a good stock?”

“Is Westpac a good stock?”

“Is Apple a good stock?”

The question is always impossible to answer.

In reality we shouldn’t even be talking about the stock itself.

What we should be asking is:

“Is Qantas a good business?”

Because to find success in share investing, it’s important to understand the share itself is meaningless on its own.

What you want to understand is the business behind those shares.

Here’s a more useful way to think about stock investing:

Say you’ve inherited a fortune and you want to use it to buy a business.

A business broker says to you:

“Sure! I’ve got a great business to sell you. The price is $10 million. Would you like to buy it?”

What is your answer?

Obviously your answer should be “I don’t know”, because you know nothing about the business yet!

However, for some reason people don’t think like this on the share market, even though it’s exactly the same situation.

How can you buy a stock by only looking at the price, and knowing nothing about the business?

So, what should a rational person do instead?

To start, we know the business price is $10 million.

Is that a good price?

Well, it depends.

On what?

On how much money it makes (duh!).

So the first question before buying the business would be: How much money does it make?

Say it makes $50,000 per year.

That means you would need to wait 20 years before recouping your $10 million investment, and that’s assuming the business can survive 20 years.

Does that sound like a good investment?

No, it sounds shit.

But let’s say it makes $5 million per year.

Does that sound like a good investment?

Definitely! After two years you would have recovered your $10 million investment, and then you’ll make a sweet $5 million every year after that.

So just from this one question – “How much does the business make?” – we’ve managed to make a significantly better decision.

So let’s go back to our original question. If someone were to ask me “Is Qantas a good stock?”, my response would be – “How much money does Qantas make?”

Funnily, probably 80% of people who buy Qantas stock have no idea.

It’s no wonder most people lose money in the share market.

But once we know, we can make a better decision:

If Qantas shares are $5, and they make $0.10 in profit per share, then no, I’m not interested and I’m guessing most other people won’t be either.

If Qantas shares are $5 and they make $2 in profit per share, then it has potential to be a great stock!

We would then go through a list of other questions to help make our decision even more informed and rational, such as:

“Who manages the business?”

“Is profit growing or falling?”

“How competitive is the industry?”

“How much debt do they have?”

And so on and so on.

The lesson is, there’s no such thing as a “good stock” and a “bad stock”.

We are not buying stocks, we are buying businesses.

The “stocks” are just a way for the businesses to be divided up into smaller shares, so we don’t need to buy the whole thing. We can just buy a few shares and become a part owner instead.

Yet, all the questions you would normally ask when buying a business remain the same.

The intelligent question is not, “Is Apple a good stock?”, but “Is Apple a good business, how much money is Apple making, what new products will Apple come out with next year, is the Apple CEO performing well, how much debt does Apple have?” and so on.

Once you start to look at stocks this way, investing starts to make a lot more sense.

The sharemarket will no longer feel like a casino, but a marketplace, where you can make informed decisions and hunt for deals and bargains.

Interested in learning more?

My course Simple Stocks teaches you how to answer all these questions and more. If you’re at the beginning of your stock investing journey, Simple Stocks will help guide you from Day 1 to building a thriving portfolio. Check it out here.

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