So you’re broker … so do you have a tip for me?”

The thing about tips is, by the time you hear it, there has been so much sauce added, you won’t know whether it’s a spanakopita or a tiropita. Like any good story repeated a thousand times over, some embellishment is required to make it sound more interesting than it actually is, and only the best parts are told. A tip could also come in the form of those adverts on the side of websites. They sound innocent and enticing enough. They request your email address in exchange for their best stock tip. I’m happy to tell you right here and now for nothing, you get nothing for nothing.

Don’t get me wrong, hearing a stock tip, an idea, a story, can be a good thing. However, most of the time, it is a ticking time bomb ready to blow your capital and portfolio up. The reality is, you’re going to hear plenty of tips in your investment lifetime … it’s a matter of what you do with them. I’m not going to be narrow-minded and suggest you toss them all in the bin. I will instead provide three suggestions below that you might find useful.

1. Take a look at the stocks chart. A chart not only tells you the historic performance of a share price, it can also tell you whether you’re one of the last people to hear the story. Let me give you an example. I was given a tip once (one that I didn’t ask for) by a person at a birthday party. When I got into the office on Monday, I brought up the chart of this company. It had gone from 3.5c to 9c in two months on the back of a positive drilling update but had retreated back to 5.5c. That person was telling me that yet another announcement was coming. As I had anticipated, no announcement eventuated and it just reinforced my view that the ‘smart money’ had already been in and out of the stock. That tip was six months old, it’s just that the bloke didn’t know it.

In this day and age, with emails and instant messaging, word can spread faster than ever before. If you hear a tip and the stock has already rocketed, there is a good chance that you’ve heard it too late. If the share price has moved slightly, or not at all, perhaps, and I emphasise perhaps, there is something to work with.

2. Ask the person who is giving you the tip whether they own any stock. If not, why are they promoting it? If so, what price did they get in at? If they have got in at a much higher price than what the stock is currently trading at, then perhaps they arrived at the party too late. Everyone has already had a good time and they’ve gone home. That’s not a party you and your capital want to go to. If their entry price is equal or below the current share price, then perhaps, and I emphasise perhaps, there is something to work with.

3. Undertake a medical on the company’s balance sheet. Most tips revolve around small cap companies because everyone wants to outlay a small sum in exchange for a big reward. Most small companies (especially ones in the resources sector) require capital to achieve their promises. Companies tend to raise capital after a share price has gone for a run. If the company’s balance sheet has holes in, then more likely than not, so does the tip. By holes, I mean lots of long term debt. It is always wise to divide the company’s debt by its market capitalisation to get an idea of its financial health. A figure close to, or above 0.4, isn’t a good sign, especially if the company isn’t making a profit. Most small cap stocks don’t turn a profit. If the company is well capitalised and has a good amount of cash in relation to debt, then perhaps, and I emphasise perhaps, there is something to work with.

The lesson here is, a ‘tip’ should only be just another component of your idea funnel. By components I mean newspaper articles, research reports, investments made by listed investment companies etc. Your idea funnel is one of your most important assets as an investor. The ideas lead to further research, and if the company (remember you’re investing in a company, not a tip) meets your fundamental filters, it should only then be considered as viable and sensible investment.

There is output and there is outcome. The two are positively correlated to each other. Remember, you get nothing for nothing.

*Sam Fimis is a stockbroker at Patersons Securities and author or Premiership Portfolio: 6 Step Guide to Succeeding in the Stock Market | www.premiershipportfolio.com | @premportfolio