Investment Analysis Definition
Investment analysis is defined as the process of evaluating an investment for profitability and risk. It ultimately has the purpose of measuring how the given investment is a good fit for a portfolio. Furthermore, it can range from a single bond in a personal portfolio, to the investment of a startup business, and even large scale corporate projects.
Investment Analysis Meaning
Investment analysis means the process of judging an investment for income, risk, and resale value. It is important to anyone who is considering an investment, regardless of type. Investment analysis methods generally evaluate 3 factors: risk, cash flows, and resale value.
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Evaluating Risk in Investment
When evaluating risk in investment, there are three factors that you need to look at: risk, cash flow, and resale value.
Factor One: Risk
The first factor evaluated in any investment analysis is risk. The reason for this is simple: if the risk of the investment is too great then loss is quite likely. In this case, cash flows and resale value generally do not matter because the investment is worth nothing. To evaluate risk, one simply uses a variation of the following formula:
Rate of occurrence x the impact of the event = Risk
Despite this, risk is not a definite factor. One must evaluate all the factors related to the investment: market, industry, governmental, company, and more. In this way evaluating risk is as much of an art as a science.
Factor Two: Cash Flow
The second factor of investment analysis is cash flows. Cash flows occur in many ways: dividends from a publicly traded stock, interest payments on a bond, or even free cash flow which can be distributed to the investors in a small business (again, in the form of dividends). Cash flows are one of the methods of repayment on an investment. Thus, an investor will want to evaluate cash flows to see if they repay the investment while also repaying the assumed value of the risk on the investment. Many methods of evaluating cash flows exist: future value of cash flows and Discounted Cash Flow Analysis. Others provide each investor with a method of analysis based in the type of investment they are considering. Regardless, ignoring the analysis of cash flows is a quick path to loss of investment capital.
Factor Three: Resale Value
The third factor of investment analysis is resale value. Profit from resale is made through a gain in the market value of the asset. When the asset is sold to another investor for a value higher than the original purchase price, profit from resale value has occurred. In the process of investment analysis, an investor will want to measure the expected rate of growth on the asset to make sure that the value of this and any associated cash flows are larger than the loss of investment and the estimated value of the risk of the investment.
All of these methods of investment analysis are applicable to any investment: stocks on the stock market, treasury bills, the purchase and growth of a business, or even currency trading. Though each has a purpose-built method for investment analysis, each requires this if the investor is to be sure that the risk is worth the reward. Though investment for real estate decisions will be different than for a stock, the basic concept is the same.
Investment Analysis Example
For example, Dion is a personal financial planner. With this job Dion spends all of his days making sure that investors, from employees to entrepreneurs, are choosing investments which fit their life plan and needs. Dion must be an expert in investment analysis and portfolio management if he is to keep his position in the field.
Currently, Dion is currently working with two clients. He’s working with a successful 25 year old and a 90 year old grandmother who is a retiree. He must make careful decisions for both. But we will soon find that these decisions can be drastically different. It all begins with an investment analysis form to make sure he understands the goals of each party.
Making the Decision
When Dion talks with the 25 year old he sees passion. This young woman, graduating at the top of her class and moving on soon to be one of the top consultants in a business development firm, has success on her mind. She wants to maximize her investments to create the future she chooses to live. She is not afraid of risk because she has no family, mortgage payments, or other obligations.
On the contrary, the 90 year old woman is concerned with stability. Her age keeps her from reentering the work force. This woman wants to make sure that she can survive and leave what is left from her life to her children.
For the 25 year old, Dion takes a more aggressive approach. He chooses stocks in technologically related companies, aggressive mutual funds, and more. Though he still keeps stable platforms, like bonds, he even chooses the most aggressive of these. Dion wants to help this woman fulfill her dreams. In addition Dion wants to allow her to find stability later in life, as per her desires.
For the 90 year old, Dion chooses the most stable of investments. Government bonds, treasury bills, and light risk mutual funds are a large part of her portfolio. In addition, Dion wants to assist the woman so she can continue to live the comfortable life she is accustomed to.
Dion has been successful in the use of investment analysis software and concepts. Each woman has achieved their goals. Thanks to the help of a trained financial advisor, they can move on to pursue their life with the expectations they had. Download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your investment value.
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