The UK stock market can be a confusing place, especially when analysing which companies to buy in my Stocks and Shares ISA. Over the years, I’ve managed to distil it to five things that I look out for. Here they are.
#1 – Diversification
A good company is well diversified. The reason is because I don’t want to invest in a firm that puts all of its eggs in one basket. This increases risk.
But diversification applies to a UK stock in many ways. I’m looking for companies that have diversified revenue streams and products. This means that if one product or division is hit, then the others are likely to make up for the loss.
I also like to see a UK stock that derives its revenue from different geographical regions. This is true of FTSE 100 shares like Unilever, but what about UK small companies? Well, here I’d like to see customer diversification. It’s risky when a small-cap stock derives all of its revenue from one customer or contract.
#2 – Management
I think the key to a successful UK stock is a strong management team with lots of experience in the sector the company operates in. For me it’s very simple. If there isn’t a skilled captain to steer the ship, how do I expect it to stay afloat.
It’s one thing to have strong leadership. But if they don’t have the relevant experience then, in my opinion, that company could make big mistakes. It’s management’s responsibility to set the company’s strategy and adhere to corporate governance. So when analysing a UK stock, I’m certainly reading the biographies of the management team.
#3 – Financials
I’m looking out for a UK stock that has healthy finances. This means a strong cash position and low levels of debt. But if a UK stock has debt, I’m more concerned whether it can afford to pay its liabilities. I think it’s worth highlighting that not all leverage is bad. It can be used to fuel growth, but the key issue is affordability.
It’s great if a UK stock can pay a dividend. It usually shows that the company is in a strong financial position. But I also look out for how supported are these income payments from the company’s earnings. Again, the main criteria is affordability.
#4 – USP
A UK stock should have a USP (unique selling point) to distinguish itself from the competition. This should help revenue growth, which is something I also look out for.
The company also should have high barriers to entry, otherwise the competition could copy its products. These companies are unlikely to compete on price, which means profit margins could be high. I like a UK stock that delivers strong and consistent profit margins.
#5 – Valuation
I generally use the price-to-earnings (P/E) ratio to analyse a UK stock’s valuation. If this is low, then the company is cheap, and vice versa. I typically compare the P/E ratios of a company with its listed competitors to see that I’m not overpaying.
But I’m mindful that some stocks are cheap for a reason. This is where I’ll have to do some digging around to find out the reasons why a UK stock has been hit. If I can understand what’s happening, then this could be an opportunity for me to invest in.