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Investing Due Diligence: What It Is and How to Do It

Wednesday, March 17, 2021 03:57 PM | Neal Farmer
Investing Due Diligence: What It Is and How to Do It

Taking the time to do your due diligence, or "DD" as it is often referred to online, on most things in life is a worthwhile use of time, and it's no different when it comes to investing.

Due diligence can mean a lot of different things in finance with the original definition relating to an examination or review of financial statements before entering into a transaction with another party. For the average investor due diligence just means that you took your time before making an investment decision by analyzing what is important to you in an investment.

What Matters to You?

Before doing any DD on an investment opportunity, you need to know what you are looking for from that investment and what you believe is most important to achieving your goals. For a long-term investor that is most concerned about the underlying fundamentals of a company, analyzing the firm’s earnings, growth rate, and balance sheet will be the most beneficial to making a sound decision.

If an investor is primarily concerned with the long term outlook and plans to buy and hold, then current market sentiment and short term volatility shouldn’t be the primary focus. However, shorter term investors or even day traders, will be far more concerned with how the market currently perceives a stock and if a reversal in the stock’s trend looks likely.

Taking in all the information you can will undoubtedly help you get a complete picture before deciding to invest in a company. The reality though is that few have the time to go through every page of an earnings report while also analyzing the trading trends over the past six months of each stock they think about investing in. Doing your research on an investment is great but making efficient use of your time is equally as important. Knowing what you are looking for is necessary before any due diligence can be done.

Where To Do Your DD?

Once you know what to look for, the next step is where to find the information relevant to making an investment. For the shorter-term investor interested in current market sentiment, they may take the time to analyze how a stock is trending now and do their own technical analysis. These investors may even go to Reddit where some have already done their own due diligence on particular stocks such as in r/investing or even r/wallstreetbets.

Analyzing trends in volume, short interest, beta, etc. will be some of the primary metrics looked at by these types of investors. InvestorsObserver’s short-term technical score can give a quick insight into a stock's recent trading patterns.

For longer term investors, valuation metrics and underlying fundamentals are critical to research. Quarterly earnings reports will be the go to for many of these portfolio managers as it shows the current health of a company and the growth rate of the firm. Businesses that are constantly missing earnings expectations and not improving year-over-year will not give long term investors reasons for confidence. Additionally, analyst ratings are a go to for these investors as Wall Street analysts have already done their own due diligence on these companies and have a wealth of experience doing so.

Again, InvestorsObserver’s proprietary scoring system gives investors a quick view on how a company ranks based on valuations, analyst rankings, and long-term technical scores. These longer-term scores grade stocks based on PE ratios, growth rates, Wall Street ratings, and trading patterns over the past several months.

Wrapping Up

Finally, an investor should still always do their own due diligence and not completely rely on the research of others. Using that information is a great way to get started and have an understanding of what you are considering investing into.

Still though, traders should be investing into companies they believe in. So before making the final decision to buy Apple (AAPL) stock, you should still ask yourself whether you see the iPhone, iPad, Mac, etc. continuing to dominate the market in the future based on current performance and outlook.

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