What Makes for a Good Investment?

When you think of a “good” investment, what comes to mind? Contrary to the what most people think, there is no magical business you can pick out of the market and expect to become a millionaire over the night.  Investors are not traders. Investments take time.

The process of looking for a business to invest in isn’t just about what tickles your fancy or how great the profits are today.  To choose a venture that will gain on the long run involves looking into its performance history, the data and numbers, the stability and reliability, its ranking and how well prepared you are for the risk and its management. There are also questions to ask yourself to help you along the way.

Investopedia:

To invest – To put money into financial schemes, shares, property, or a commercial venture with the expectation of achieving a profit.

Investment – In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit.

What to look for in an Investment

Earnings

Earnings are the after-tax profit a company has made over a specific time period like a quarter or year. This profit is basically measured against the analysts estimates to see if it has outperformed the previous time period. You want to look at the growth of the earnings. Is the growth rate stable, consistent, – what is the pattern? Compare the earnings growth to that of the industry and the market, is it ahead? Look at the quality of the earnings, what are they doing in relation to the revenue and costs of the business? Does it look sound – how faithful are the numbers to the actual performance?

Return on Equity

Return on Equity (ROE) is how effective the company’s management is in turning a profit out of the money shareholders have invested. Is it good? Has it been consistent? How does it compare to other businesses in the industry? ROE is usually considered the most important profitability metric.

These metrics are a good starting point to get an overall gist of what is and has been going on in the money making section of the business. Remember, no metric can be taken alone as enough to make a final decision. It is also very important to look at the relative value of the numbers. You always want to compare to other businesses of the like, to the industry and market as a whole.

What you want to ask yourself

Risk Management

Careful risk management is the way of good investors. You want to minimize the risk for the best possible gain in the long run. Look at the data, where is there uncertainty? What and where are the potential losses for the investment? You want to be able to mitigate and effectively manage any risks. Can you identify the risks and see an effective management strategy?

Long-term Viability

 Invest with the long term in mind. If you don’t see yourself having stock in the company in the next 10years, it isn’t the choice for you. Investments gain profit over an extended period of time. This is because investors are not traders; investments withstand the fluctuations of the market, with the underlying premise that prices rebound eventually. Any losses endured, if patient, will be made up for on the long term.

Take it from one who is considered by many to be the most successful investor in history, Warren Buffet, “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”  Would you be happy to have it 10 years down the line?

Simple business model

It’s a good sign when a business has a clear and easy to understand business model. When there is transparency, a clear model and structure to implement, it is then easy to grow, easy to franchise. More often than not, it also usually comes with a stable and good growth curve. Does it have an easy to understand business model?

No one can predict the future of the market, of stocks, of natural disasters. Anyone who says they can, is a charlatan. No serious successful investor will claim to know the future, but what they will do is observe the history and patterns of the business, its data, analyze where it is relative to other businesses and the market, and ask themselves whether all things add up. Use all of your resources to make an informed and risk calculated decision.

“In the business world, the rearview mirror is always clearer than the windshield.”- Warren Buffet.

Do your research, think long-term, and try not to get overwhelmed by the many opportunities available.