Performing a due diligence is an important activity when considering investment. The investigation or audit includes the review of financial records. Due diligence refers to the research done before entering into an agreement or financial transaction with another party.
Investors perform due diligence before buying a security from a company. Due diligence also refers to the investigation a seller performs on a buyer, that might include whether a buyer has adequate resources to complete the purchase.
Types of Due Diligence
Due diligence is performed by companies seeking to make acquisitions, by equity research analysts, by fund managers, broker-dealers, and investors. The due diligence on a security by investors is voluntary. However, broker-dealers are legally obligated to conduct due diligence on a security before selling it, which helps to prevent any issues arising with a non-disclosure of pertinent information.
The due diligence meeting is a process of careful investigation by an underwriter to ensure that all material information pertinent to the security issue has been disclosed to prospective investors. Before issuing a final prospectus, the underwriter, issuer and other individuals involved (such as accountants,syndicate members, and attorneys) will gather to discuss whether the underwriter and issuer have exercised due diligence according to national legislation.
Performing a Due Diligence for Stock Investing
These are related to equities, debt instruments, real estate, and other investments. There are many types of securities in existence and as a result, many variations of due diligence that might be needed for a specific investment.
It’s also important to consider risk tolerance when performing due diligence. Investors might have different risk tolerance levels and investment goals. Due diligence can result in different interpretations of the findings depending on who’s performing the research.
Steps to Performing a Due Diligence
- Analyse the capitalisation (total value of the company)
- Revenue, profit, and margin trends
- Competitors and industries
- Valuation multiples
- Management and share ownership
- Balance sheet
- Stock price history
- Stock dilution possibilities
- Examine long- and short-term risks
Analyse the Capitalisation (Total Value of the Company)
A company’s market capitalisation can provide an indication of how volatile the stock price must be, how broad the ownership might be, and the potential size of the company’s target markets.
Large-cap and mega-cap companies tend to have stable revenue streams and a large, diverse investor base, which can lead to less volatility. Mid-cap and small-cap companies may only serve single areas of the market and typically have greater fluctuations in their stock price and earnings than large corporations.
The size and location of the company might also determine which exchange the stock is listed on or where it trades. You should also confirm whether the stock is listed on the A2X, ZAR X, 4AX, or the JSE.
Contact us for more information on conducting a due diligence for your company.