Experts: Never Buy a Stock Until You’ve Answered These 9 Questions

Though not the only asset you can invest in, stocks are well regarded as investment vehicles for a few key reasons. Stocks generally offer higher returns than bonds or gold, and they have averaged close to 10% annually since 1926. Stocks are also known to outpace inflation and act as a hedge against it.

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By all means, if you haven’t yet explored the world of investing in stocks and you’re looking for ways to make your money make money, you should start exploring now. But don’t pull the trigger on purchasing any stock before you’ve asked — and answered — these nine expert-provided questions.

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Do I Understand What the Company Does?

Robert R. Johnson, Ph.D., CFA, CAIA, professor of finance at the Heider College of Business, Creighton University , said he’s found that many people will invest in a company without fully understanding its business model.

“They simply invest because either somebody tells them it is a good investment or because it has been going up and they believe that momentum will keep the stock going up,” Johnson said.

Not understanding the company you’re investing is a major mistake that could backfire on you and cost you serious money.

“In the song ‘Superstition,’ Stevie Wonder sang, ‘When you believe in things that you don’t understand, then you’ll suffer,'” Johnson said. “What I would say to investors is ‘When you invest in things that you don’t understand, then you’ll suffer.'”

Do your research to understand the ins and outs of how a company you’re considering investing in makes money, and then dig around to ensure that its business model is sustainable.

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What Is Driving Me To Invest In This Company?

What’s the root of your desire to invest in a particular company? You need to know.

“Many investors are swayed by stories and ignore fundamentals,” Johnson said. “Nobel Prize laureate Robert Shiller explained this phenomenon in a book entitled ‘ Narrative Economics: How Stories Go Viral and Drive Major Economic Events .'”

In this book, Shiller explores how popular narratives can drive the decisions of individuals and create market inefficiencies, Johnson explained.

“Students of economics are taught that individuals are rational decision makers, yet we witness economic booms and busts that can’t be explained by supposedly rational behaviors,” Johnson said. “One need look no further than the current bubble in cryptocurrencies or the housing bubble that precipitated the financial crisis to see how seemingly irrational narratives can drive behavior and create economic crises. Investors would be wise to take Shiller’s advice and consider the narrative. This is how investors become speculators and how speculation is akin to gambling.”

What Are the Company’s Financials Like?

You don’t have to be a seasoned investor to get a thorough understanding of a company’s financial situation. All of this is made public so that prospective investors have all the information they need.

Edward Corona, trader and publisher at The Options Oracle newsletter, said to look at the company’s revenue growth, profit margins and debt levels, as these are each critical factors that will tell you whether a company is financially healthy.

“It’s like checking a car’s engine before you buy,” Corona said. “Don’t skip this step.”

What’s the Stock’s Valuation?

You need to know any given stock’s valuation before you make the move to buy in.

“Is the stock overpriced compared to its earnings (P/E ratio) or its book value (P/B ratio)?” Corona said. “You don’t want to pay too much for a stock, no matter how much you like the company. Comparing these metrics with industry averages gives you a better sense of value.”

Who Are the Competitors — and Could Those Companies Be Better Investments?

When deciding what company to buy stock in, determine who the competition is and whether or not you may want to invest in any of those companies instead.

“If a business looks like a good investment, perhaps there are competing operations that are even better,” said Asher Rogovy, chief investment officer at Magnifina . “Studying competitors can also help an investor contextualize the opportunity and provide conviction for the original idea. Many industries use common benchmarks for financial metrics.”

What’s the Industry Outlook?

Keep in mind that even the best companies can struggle if the overall industry they’re in is having a rough go.

“Look at trends and forecasts for the company’s sector,” Corona said. “For example, are they in a growing industry like renewable energy, or are they part of a sector that’s stagnating?”

Who’s Running the Company?

Before buying a stock, know all that you can about who’s running the company and whether they’re doing an efficient job.

“Strong leadership can make or break a company,” Corona said. “Research the management team’s track record. Have they successfully grown other businesses? Do they have a stake in the company? CEOs who own stock are often more motivated to see the business succeed.”

What Does the Worst-Case Scenario Look Like?

All investing is risky business, no matter how vigilant you are. Get comfortable with this by asking yourself, “What would the worst case scenario for my investment look like?”

“Thinking hard about potential risks can help avoid losses,” Rogovy said. “For a research-stage biotech company, this might mean the science won’t ever work and no pharmaceuticals will be commercialized. For a utility company, this might mean a recession results in a temporarily reduced dividend.”

Is This the Best Use of My Capital?

“A lot of beginner investors approach stock picking from the perspective of finding an investment that won’t lose money,” Rogovy said. “While this goal is certainly important, a better approach is to find investments that will provide the best return given the risk. Space in your portfolio is a finite resource, so it’s best not to waste it on average stocks.”

Before buying any stock — but especially if you’re on a lean budget — conduct a careful analysis and make sure the investment is worthy of your hard-earned money.

This article originally appeared on GOBankingRates.com : Experts: Never Buy a Stock Until You’ve Answered These 9 Questions