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 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.
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.