by David Ireland

Created on: June 18, 2008   Last Updated: June 24, 2008

The only means by which any investor should legitimately make a stock purchasing choice is through the process of detailed research. It is not sufficient to guess that things will not get much worse and that there is more blue sky potential than downside risk. Companies do fail. These companies become worthless. There are many recent examples.

Financial companies are among the most difficult to research effectively. Many financial companies have complex inter-dependencies with others in the market.

Begin your research by trying to identify the companies by TYPE. For example, in which areas do they have most of their exposure? Are they lending to big business, government, small enterprise, other banks, for development, for domestic housing and what is their oversas exposure?

SIZE is a consideration also but bigger is not always better.

HISTORY is important too. This is not just dividend history but should include stability of management, they way they have handled previous credit market problems and the performance quality of their major customers.

Growth history can be one of the most important factors to assess. If the company has grown at a rate that is well in excess of the market average for the sector, then care should be taken to ensure that the source of the growth has been the result of quality management decisions and not for example, over priced merger and acquisition activity. Little or no growth can be just as problematical. Low growth percentages can be a sign that management is struggling to cope with changing market conditions and should be viewed as very suspect.

PERSONNEL can often provide tacit indicators of relative market performance. If there has been a pattern of key personnel departing, then it might suggest that there are systemic management difficulties, performance targets not being met, or even better performing companies offering better conditions. The performance history, qualifications and relevance of top tier management also warrants scrutiny. Look at the length of tenure, performance bonusses, personal investment in the company and input.

The special thing about financial sector companies is that the value of their physical ASSETS is often only a tiny proportion of the total valuation. More than anything, it is the quality of the financial assets that will be the primary indicator of longivety. The loans need to supported by prime mortgaged, first class, assets with professionally responsible valuations. Lending should be tied to the ability to repay interest and debt not the valuations. Valuations should only be used to determine the size of the loan. Very few will ever fully understand how subordinate debt should be valued so avoid companies with large amounts of their loan folio that is exposed to substandard second and third mortgages and other debt derivitives.

Once you are satisfied with your research, and don't forget that there are plenty of responsible professionals to help, timing is the only question left. When to enter the market? If you are hoping to sit back and pick the bottom, good luck! Given the huge falls in the market, history tells us that it will rise again. Will it rise before it falls further? Guess! Responsible investors will invest on a regular basis for the long term. Stick with quality, it won't make you the richest but it will make you rich.

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