Often Underlooked Yet Important - Must Read for any Serious Investor

Morning everyone.

Today I'm about to share a topic which may be something rather new to some of you and probably often underlooked but one that is very important when it comes to investing in general.

You may ask, what is so important for anyone who wishes to invest? This important but often ignored aspect is what I term: Investment Due Diligence.

Honestly speaking, how many of us undertake a serious and comprehensive due diligence before we invest? We might do so when we invest in say something like property as a large amount is involved, but for stock investing, do we usually apply the same level of scrutiny (which we should) as well?

Well, probably some of us do probe and analyse but do we actually ask the 'real' diligence questions? Questions that raise a possible concern about the company that we are about to invest in.

These could range from questions like does the company utilise share buybacks more often than is reansonable to distribute cash back to investors vs declaring dividends? Does the company have certain items on the balance sheet which poses more risks than what meets the eye? Are there structural issues within the company's landscape which pose inevitable challenges for the business over the longer run?

These are important questions to ask but are also questions that tend to be left out because they seem to be either too complex or cumbersome to ask and/or understand. Nevertheless, other than using the usual approaches to understanding a stock, proper due diligence should always be part and parcel of the investment process as well.

I use a local water treatment company as an example that I encountered a few years ago. I bought into the stock at a high price in Q2 2011. I sold off the stock at a relatively large loss just last year. There were many factors which I initially felt were great for the stock:

1. Constant demand for clean water
2. Good media coverage
3. Large business moat
4. High barrier of entry, amongst others.

However, what I failed to appreciate and realise was how highly capital intensive the business was and the effects of a constant need to generate high levels of capital to run a business. The business is  highly capital intensive (which is required for the water desalination plants, R&D, etc) but the returns were much more moderate and spread out over a long period of time (via utility bills that both consumers and corporates pay over time). Of course this is not to state whether it was a good or bad investment, but a case study to share the important of practising proper due diligence before buying any stock.

So remember, one of the cornerstones of good investing is proper due diligence. Understand the business well and you will be better equipped to make better investment decisions!

Signing off
Transitioning Stock Investor