Ideally your homework should cover the following points.
- What does this company do? What business is it in? How big is this company?
- Has the company had a consistent past record of sale, revenue and earnings growth? Or is the company headed for a turn around?
- The most important part of your homework, the investment thesis. What makes this a good investment? Is the company offering any product or services that is revolutionary or just executing better than others? Does it have a strong brand name? Or is the company just plain undervalued? Are there any business or economic trends taking place that could make this company valuable in the future?
- Equally as important, what is the time frame for this investment? What do you estimate the company/stock to be worth by that time frame?
- What are the risks associated with the thesis?
- What is the exit strategy?
I have made this mistake many a time of buying companies without doing due diligence. For example, I bought this company Insteel Industries (IIIN) because I read an article at The Motley Fools about how this company has a great future. This company made steel reinforcing products, and we were at that time in a commodity bull market (and still are). The company was down from its highs, and I thought this would be a good time to open a position. After I bought it, it went down further, and I continued adding to my position, until I realized this company is going no where and sold it for a 30% loss.
Another mistake was buying the drug/biotech company called Dendreon Corp. (DNDN) because I heard a called in Jim Cramer's Mad Money show say there is a good chance that its provenge drug has shown excellent results in studies and would be announced at a medical conference. As expected, the study results were not that great, and the stock moved lower from where I purchased. But since this was strictly a trade, I cut my losses quickly.
Never buy a stock based on tip, rumor or speculation. It will more often than not leave you in a world of pain.
