Five Questions to Ask Before Investing in Something

According to businessman and author Seymour Schulich, investors should ask themselves 5 questions when screening a potential deal. 🙂 Here’s an excerpt from his book, “Get Smarter.”

1. How much can I make?
2. How much can I lose?
3. How do I get my money back?
4. Who says this deal is any good?
5. Who else is in the deal?

I think these are good points to remember and I certainly use them before I make any financial decisions.

Normally we want a large margin of safety between how much we can make (upside) and how much we could lose (downside.) If the odds are not at least 75% in our favour then it is better to look elsewhere. To increase our chance of success we must know how to accurately assess the odds, and have the discipline and patience to act only when the odds are heavily in our favour. If our analysis are accurate then we can be certain this strategy will work due to the law of large numbers theory.

How we get our money back should be considered before making any deal. There are two parts to this: liquidity, and exit strategy. A rental property is not very liquid, but a publicly traded REIT that holds rental properties usually is. As for exit strategy, we need to come up with a systematic plan to sell the investment and commit to it. This prevents us from trading on emotions. One stock I bought this year is Royal Bank (RY.TO.) It has a growing dividend year after year, and trades at a decent valuation with a P/E ratio of 13.6. I plan to exit my position in this stock either when I retire, or if RY cuts its dividend by more than 35%. Those are my only conditions. So if there’s market correction and the stock price falls 50% I will continue to hold it. This way, I don’t sell prematurely and miss out on future gains.

I look at reports and opinions by stock analysts to determine if other people think the investment has potential. One good source for this is stockchase.com. It curates professional opinions about any company on the market. Here’s a blurb for RY.

As for who else is in the deal, I look at how many institutional investors are holding the investment. These are large pension funds and endowment funds that have to scrutinize all possible aspects of a security before buying it. According to Google Finance, Royal Bank has 53% institutional investor ownership. That’s pretty high so I am more confident that RY is a good long term investment.

There are tons of potential assets we can buy. But by asking ourselves these five questions we can screen our options and narrow down our options which makes the process a lot easier. 🙂

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Random Useless Fact

The world’s largest broccoli are grown in the United States.