Assuming your colleagues don’t invest in shares, if you were to ask them why not, the first answer would most likely be that they don’t know where to start. The second answer may be that even if they did know where to start, they wouldn’t know how to pick a good investment.

Here at Hatch, we’ve taken care of the first question by providing an investing platform where Kiwis can access the most recognisable companies in the world. But the second is one that every investor will wrestle with at some stage. It might feel overwhelming at first, but start with learning a little bit each day, and you’ll quickly build the confidence to make smarter investing choices. Here are some essential tips for you to use when researching your next investment.

1. Start with what you know

“Never invest in a business you cannot understand.” - Warren Buffett

Warren Buffett (only the greatest investor of all time) often uses the concept of a "circle of competence" when investing. This circle of competence consists of all the businesses that an investor is familiar with. For example, someone who has spent the last ten years working in a clothing store would be able to pinpoint the strengths and weaknesses of retail businesses and evaluate them against the competition. 

With investing, Buffett suggests it’s best to start with a sector (e.g. companies in technology, energy, or healthcare) or a specific company that you know. Think about the brands you buy and companies whose business models you understand. You can start a watchlist in Hatch of these companies while you do your research and get to know them a bit better. 

Research how the company is doing and learn more about the sector it operates in. Get a sense for:

• its position in the market

• main competitors; and

• is the market as a whole growing?

A simple Google search can be the easiest place to start before delving into more detailed information.

2. Keep an eye on the news

Warren Buffett spends five to six hours per day reading newspapers and corporate reports. We might not all have the desire to build an empire, so maybe start with scanning the news each morning. Set up Google news alerts on the companies you’re interested in and their competitors; and keep tabs on general market and economy news with CNBC or Yahoo! Finance. 

Start to consider knock-on effects of certain news reports. For example, a spike in the oil price will have a positive impact on the share prices of oil companies, but a negative impact on transportation companies, such as hauliers and airlines, whose fuel bills will increase. Trump’s tariff measures might affect companies that are reliant on Chinese production or parts - like Apple. A tip is to pay particular attention to the news that actually affects a company’s future prospects or profits, not necessarily the noise or marketing spin that fills much of our news feeds.

Pro tip: Reading analyst reviews like Morningstar, JP Morgan, and UBS will help you pick up on trends in the market they see as likely to affect the company's future.

3. Consider a company’s financial performance 

To get a clear picture of a company's overall financial health, it pays to look into company finances, and the best place to start is the company’s annual report. Reading the financial statements in the annual report can be the key to understanding the value of a company. You can then take that knowledge to compare its performance with competitors and other businesses in other sectors.

In the annual report, the company’s balance sheet tells us what they own (assets), what is owed (liabilities), and what’s leftover (net worth) and the income statement shows money coming in (revenue), money going out (expenses), and what's leftover (profit). Most annual reports include a letter from the CEO, explaining the successes and shortcomings of the past year in simple language. Annual reports must be published on the stock exchange a company is listed on, but are also freely available on company websites. Here’s an example of Netflix’s annual report.

Pro tip: Look into the management team and company culture. Who’s running the company? Do the directors hold shares in their own company? Have they increased their shareholdings, indicating confidence?

4. Become familiar with financial ratios

Using the financial statements from the annual report, you can figure out a number of financial ratios to help determine if a company is worth investing in. Ratios are also used to compare the company you are looking at with other similar businesses in their industry. The goal is to understand how to calculate and use every financial ratio, but you have to start somewhere. Below, we’ve shared three of the more popular ratios that offer an insight into a company’s potential.

Price-to-Earnings (p/e)

The p/e ratio is the price an investor is paying for $1 of a company's profit. All you need for the p/e ratio is the most recent share price, and then you divide this by their earnings per share. Earnings per share, or eps, is the company's profits attributed to each outstanding share. On December 3, Netflix's share price was $309.99. Netflix's eps for the previous twelve months was $3.13. Therefore, Netflix's p/e ratio for December 3 was 99.04. In other words, investors are paying $99.04 for each dollar of Netflix profit. Generally speaking, a p/e ratio of more than 20 is considered high and suggests investors are counting on strong growth. 

Different sectors have different p/e ratios that are considered normal for their industry. For example, tech companies might have an average p/e ratio of 20 or higher, whereas financial services might have an average p/e ratio of 14. Tech companies usually sell at larger p/e ratios because they have much higher growth rates, while other industries have lower growth prospects. Most financial websites automatically provide the p/e ratio for you. With this ratio, you can more easily differentiate between a not-so-perfect company that is overpriced because it is the latest fad and a great company that may be unpopular for some reason and is selling at a bargain. For example, if a company's stock price is 50 times earnings (p/e ratio of 50),  it's likely overvalued compared to a similar company that's sitting at 10 times earnings. It can also tell you if a sector is generally overheated and overpriced, or underappreciated therefore underpriced.

Pro tip: One way to tell if an industry is overpriced is when the average p/e ratio of all of the companies in that sector are higher than the historical p/e ratio average.

Profit margin

The profit margin is what’s left after all costs, taxes, and other expenses are all accounted for and tells us the degree to which a company makes money. So if a business has $15m in revenue and $2.5m left after everything is deducted, then it has a profit margin of 17% (profit divided by revenue). In this case, the business has a net profit of $0.17 for each dollar of sales generated.

What investors want to look for is the trend over time – whether the profit margin is stable, increasing or decreasing and what reasons there could be for that. It’s a useful tool when comparing companies in the same sector. Here is a graph of Netflix's profit margin over time which currently stands at 7.49% (December 2019).

The Quick Ratio

Often called the acid test, the quick ratio uses a companies’ balance sheet to determine if it’s able to cover its bills. By dividing a company’s cash assets by its short-term liabilities, you can tell whether it has enough to cover its bills in the event of a short-term shock. If the ratio is below 1, then you know it doesn’t have enough cash on hand and could get into trouble. If a company has a quick ratio of 0.20, it only has $0.20 for every $1 in debts that are due in the next 12 months. Netflix’s quick ratio at the end of September was 0.73, which indicates that it can’t currently fully pay back its bills in a short period.

Pro tip: A low quick ratio is common within the retail industry as they are likely to rely on selling existing inventory if they had to pay their liabilities quickly. For example, at the end of October 2019, Walmart had a quick ratio of 0.20, and this wouldn’t have included the stock on its shelves.

Yikes, this feels like so much work.

Depending on your strategy, research requires time and effort. If time is something you are particularly short on, exchange-traded funds (ETFs) may also be an excellent place to start. ETFs allow investors to buy a bundle of company shares through a single purchase without having to have the expertise required to pick individual shares. ETFs that track market indexes like the S&P 500 (VOO) offer everyday investors the benefit of diverse holdings in the largest 500 companies listed on stock exchanges in the US. With over 500 ETFs on Hatch, you can also consider ones closer to your heart, like technology, green energy, retail & fashion, or diversity.

Start with a small action today. Download an annual report, watchlist the companies or ETFs in sectors you are familiar with or invest in yourself with the many resources on hand. When you are ready to invest, you can begin with just a small amount so you can build your confidence as you go. When you’re ready, incorporate some of the steps above, and you’ll be on your way to a strong investing game.