Know the 10 Questions to Ask a Stockbroker
In the wake of the Prudential Securities scandal and continuing revelations that some investment houses overlook abuses by their top-selling brokers, congressional leaders are considering laws to ferret out rogue brokers who habitually cheat clients.
However, many experts maintain that legislation does not address the real problem: that many individuals simply don’t know what questions to ask in evaluating an investment and broker.
In fact, you can quickly weigh the worth of a broker--and what he or she is selling--by asking several critical questions.
The questions are numerous, and your broker probably won’t know every answer offhand. But a good broker will find out the answers and call you back. Good brokers will also send you written material--annual reports, prospectuses, investment research reports and Value Line reports--that back up any assertions they make about an investment.
However, to save time, you should whittle down the types of investments you’re willing to discuss to things that are appropriate to your level of sophistication and ability to tolerate risk.
For instance, most people shouldn’t even consider investing in commodities, limited partnerships, stock options, initial public offerings, penny stocks, convertible securities, junk bonds and so-called derivatives such as collateralized mortgage obligations and inverse floaters, experts say.
That’s because these investments are risky and hard to evaluate--even for professionals. Smart investors know their limitations.
Additionally, you should stop considering an investment the moment that answers to your questions begin to make you feel uneasy. If you determine that a stock prospect is too speculative for you, asking whether or not the company pays a dividend is a waste of your time.
The questions you should ask depend on what kind of investment you are being pitched. Because brokers are often trying to sell stocks, here are 10 questions to ask such a broker:
1. What’s the per-share price? If the stock sells for less than $5, it’s speculative, says Hugh Johnson, chief investment officer at First Albany Corp. in New York. Unless you’re prepared to take a big risk with your money--possibly losing 50% of your investment or more--stop here; the investment is not for you.
If the stock sells for more than $5--or you’re ready to take the risk--continue.
2. Is this the broker’s recommendation, or is this a stock recommended by the brokerage firm’s research department? Some brokers have good ideas, but they’re not paid to be researchers, Johnson notes. You should consider a broker’s recommendation with greater skepticism than a researcher’s recommendation. And you should be somewhat skeptical of both.
3. What is the objective of this investment--value, growth or income? And why do you think the investment suits me? If you are an income-oriented investor--someone who needs regular dividends or interest--you can quickly eliminate so-called growth stocks, which have great appreciation potential but don’t pay current income, says David Acey, managing director and director of marketing at Wheat, First Securities in Richmond, Va.
4. What does the company do? If you don’t understand the company’s business, pass. If you’re still intrigued, go on.
5. What are the prospects and competition like in this company’s industry? Where is this company positioned? Is it a leader, an upstart, a niche player, somewhere in the middle of the pack? Investing in industry leaders in growing industries is less risky than investing in companies that are battling at the bottom of a shrinking market.
6. What is the company’s earnings and revenue history for the past five (or 10) years? A company that’s been able to boost sales and earnings in good times and bad is clearly less risky than one that has an inconsistent history.
7. Does the company pay a dividend? If so, are the dividends consistent, rising, falling or do they vary year-to-year? And what is the dividend yield? (That’s the cash dividend divided by the market price. In other words, if the company’s stock sells for $25 per share and each share pays $1.32 in annual cash dividends, the dividend yield is about 5.3%.) It’s generally less risky to invest in companies that pay relatively generous dividends because the dividend can attract investors to the stock.
8. What is the company’s price-earnings ratio? (That’s the market price divided by its per-share earnings. A company selling for $25 that earned $1.32 per share would have a price-earnings ratio of about 19.) And how does that compare to its average price-earnings ratio over the past five to 10 years? If the company’s price-earnings ratio is comparatively low, it may be selling for a bargain price. If it’s higher than average, you have to know what has changed about the company’s prospects to warrant the lofty market value.
9. How does the price-earnings ratio compare to the company’s projected growth rate? If the company’s shares are selling for 30 times current earnings, you should expect the company to be growing at a 30% pace, Johnson says. Otherwise, it’s going to take a long time for your investment to pay off.
10. Do you have research reports and other printed material that I can look at before I make an investment decision? Ideally, you want the investment houses’ research reports on the company and the industry. You want independent research, such as a Value Line report. And you want printed material from the company, including an annual report, 10-K and quarterly reports.
Brokers who can answer all these questions have done their homework.
Once you do yours, by reading the materials they mail, you’re in a great position to make a good investment decision.
Of course, that doesn’t mean you’ll never lose money on another share of stock. But it should keep you from making a habit of it.
