The Fundamental Steps of Investment Analysis

Written By Alla Levin
July 16, 2021

The Fundamental Steps of Investment Analysis

Investment analysis is a very broad term. It is usually applied in describing the different methods of analyzing investments and sectors, as well as prevailing economic trends for optimal growth. Many things can constitute investment analysis, including the ability to chart past performances and predict possible future returns. It could also be selecting an investment based on an investor’s possible needs and objectives.

In a nutshell, investment analysis focuses on examining different possible investments based on specific criteria and choosing an appropriate one. If an investment is to pan out and be successful, it is important for thorough and effective analysis to go into it. So, there is no overstating how significant it is.

Objectives of Investment Analysis

Put simply, investment analysis aims to determine how an investment is likely to perform and its suitability for an investor. Some of the most important factors to be considered here include the right entry price, the investment’s time horizon, and the investment’s role in the portfolio in general.

So, when analyzing a mutual fund, the investor considers the fund’s performance over time. The fund can also be compared to some specific industry benchmarks and some of its top competitors. When comparing funds, some factors that can be used include sector weighting, expense ratios, asset allocation, etc.

It is important to note that there’s no one-size-fits-all approach to investing. There are different types of investors and objectives, so there are different types of investment opportunities that will work for those people as well.

With all these differences and parameters, investment analysts will need to engage in strategic thinking. Since they will need to examine the thought processes that went into making their investments possible, investment analysts need to have the right balance of strategic thinking as they work.

Strategic thinking involves understanding the investor’s needs and financial situation, the portfolio in question and its performance, and more.

The Steps of Investment Analysis

Every investor needs to have a robust investment process. Going through strong analysis of potential investments will help to improve the efficiency and accuracy of your investment process. So, here are the steps you need to take while investing and the boxes that need to be checked.

Company BasicsThe Steps of Investment Analysis

If you’re investing in a company, you need to know everything there is to know about it. Check out their name, exchange listing, location, business model, date founded, etc.

For most companies, this information is available in the company 10k or annual report. If you can’t understand what the company does, then it’s a bit of a red flag. In that case, it might be better to just move on.

Securities Issues

Understand things like the number of shares, classes of common stock, rights of each issue, new stock issuance, stock buybacks, and the company’s plans for share issuance in the future.

Getting a view of this will help you understand the company’s shareholder plans. Are they just issuing new shares and destroying the company’s share value? Do they have a plan to prop up share value from a management standpoint, etc?

Financial Position

This includes viewing the company’s current ratio, debt to equity, interest coverage, off-balance liabilities, and more. No company wants to be in debt, but there are manageable levels of debt that can be tolerated. When debt and insolvency become too much, the company runs the risk of bankruptcy. Before investing, you need to be confident about the company and its financial position.

Operating Performanceinvestment analysis

Examine metrics like profit, revenues, and margins over a couple of years. Understand the company’s earnings quality and its trends. Can you predict its earnings? Or is it difficult to estimate the company’s direction over the next few years?

Predictability is important for a business – especially if you’re the type of investor who appreciates balance. You need to understand how a company makes money – and the factors responsible if they’re not.

Business Strategy

Look into the company’s business model and mode of operating. Do they have an edge that can guarantee long-term profits? How easy will it be for the company to switch if industry trends change? Have they pivoted before? How successful was it?

Market Outlook

Examine possible projections for the company’s industry and pressures that could cause issues down the line. Can the company remain operational if a recession hits? How do they plan to do that?

Investment Analysis: Valuation

Think about the fair value that an expert will place on such a business. You can use the discounted cash flow model, the net asset value assessment, or the earnings multiples.

Each of these methods comes with its merits and demerits, especially considering that the future isn’t certain. When you have to conduct the valuation of an unknown model where the future isn’t exactly certain, you could end up with false valuations and inaccurate results. Still, the important thing here is being able to buy below your valuation of the business. You can pay up for growth, but you need to watch for your return on investment.

In general, investment analysis will require a great deal of work and skill to work through. Many analysts spend countless hours poring over the details of companies in order to achieve a fair value of their investment. At the end of the day, the ideal result will be to come to a better understanding of each company and what it offers in the long run – especially in relation to the investor’s objectives.

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