Factors to consider when making investment decisions
It is important to make investments that help fulfil your financial goals and ensure that you have
a stable and secure future, but be aware that this is not always an easy process. There are several
factors you need to consider that can influence your decisions.
It is crucial that you make the right choice, and the right investments for you. Although there are
several financial instruments that can help you build a corpus, not all of them may be suitable for
you. It is important for you to know which investment format is good for you, and which ones
best fit your financial needs.
Let us take a look at a few such factors that you must consider while making an investment
decision.
Reason of investment
The first, and most important thing to consider is the reason for making an investment. While it
is true that investments are the key to a financially successful future, it is also important to
understand that not all investment vehicles are the same. Each investment objective has it’s own
pros and cons and a different objective. You must have a clear objective for your investments
and then arrive at the right investment choice for you.
In simple terms, if you are looking for a short term goal, the investment modes would be
different than the financial instruments which cater to long term goals. Knowing your investment
reason, and fixing on a goal gives you clarity on which investment vehicle is right for you.
Researching the market
Making an investment is an important decision, one which can alter your future significantly.
Therefore, it is always advisable to conduct thorough market research before you make an
investment decision. Doing this will help you understand the current market and give you an idea
of the companies you should invest in.
Knowing your investment goal and the type of investment you want to make, along with having
a good understanding of the market, will enable you to make investment decisions that are best
suited for you and help you succeed.
Risk levels
Nearly all investment vehicles carry with them some kind of risk. Therefore, it is important to
understand the risk associated with the investment before you get involved. Your risk appetite
should dictate your investments to help you make the most of your investments. If you want to
ensure that your principal investment remains safe, go for lower risk investments, though the
returns on those may not be high. If you’re looking for high returns and do not mind taking a few
risks, then your investments will look a little different.
Investment Tenure
Your financial goals must have a time limit, which implies that the investments you make also
have a specific tenure. The longer you make investments into one instrument, the higher corpus
you are able to build for yourself. You also have a higher chance of earning a profit if the
investment tenure is long term. However, not all investments provide a guarantee of positive
returns.
Depending on your financial goal, and the reason for investment, you should decide upon the
duration for your investment.
Taxations
Before you make investment decisions, it is important to consider the taxation rules, and
potential tax implications that may arise in the future. The reason is that different investments
cause different taxation levels, which can affect your investment returns. It is imperative to
understand the taxation laws and regulations before arriving at your investment. Understanding
tax laws help you make sound investment decisions, which can help protect your financial
future.
Liquidity
When making an investment decision, you should consider that you may have to liquidate that
investment to meet other unforeseen needs. You should also consider the appreciation of value
for your investment in the long run. If your chosen investment has long term potential and has
high liquidity, as an investor, you can take advantage of the price movements in the market, and
easily sell the investment if you wish.
Volatility
Volatility can be defined as the measure of how much the price of your asset can fluctuate over
time. This can be a key influencer in your financial decisions, and is one of the most important
factors to consider. Depending on your risk appetite, you should consider the volatility of your
investment. This can highly influence your investment decisions, based on your investment
objectives.
For example, if you are investing for the purpose of a retirement plan, you are likely to invest in
an instrument that has consistent returns with low volatility.
The Company
Before you invest in a company, it is imperative that you conduct a full research about the
company, its operations, finances, and market projections. This gives you an idea of whether it is
a good idea to invest in the company, and whether you see your financial goals get fulfilled by
making the investment.
Return on Investment
The ROI, or Return on Investment is one of the key determinants to consider when making
investment decisions. The entire point of making an investment is to generate returns and garner
profits. Therefore, you must always consider your ROI when making financial decisions. An
ROI can help you measure the profitability of your investment in relation to the principal
amount. In case you decide that your investment is not generating enough ROI, you can stop
investing in that instrument, and look for better options.
Rate of Inflation
Inflation is real, and it is something that is beyond your control. Therefore, it is a crucial factor
that you must consider when making investment decisions. Over time, inflation can kill your
savings, and erode your investment value. You should consider the effects of inflation on your
investments before you make them.
We hope a better understanding of the factors you should consider before you make an
investment decision will help you make sound choices and have a successful financial future.
However, nearly all investments are subject to market risks, and you should always consult your
financial advisor before you make a decision on investments.
As you consider your options, here are seven things you should know about a company before
you decide to invest:
1. Earnings Growth
Check the net gain in income that a company has over time. Look for trends. Does the earnings
growth generally increase? Even if the increase isn't dramatic, a company that has steady and
consistent earnings growth over time can be a good bet for the future.
2. Stability
Every company is going to have periods where the stock loses value. This is natural, especially
during times of economic difficulty and market upheaval. Instead, look for the overall stability as
it relates to the economic conditions. Is there a great deal of fluctuation? If so, that could be a red
flag. If, however, the company only seems to have real trouble when the rest of the market is
struggling, you might do well to consider the stock.
3. Relative Strength in Industry
Take a look at the company’s industry overall. Does the industry that the stock is in show
promise for the future? If so, look closer at the company. What is the company’s relative strength
in the industry? Is it well placed against its competitors? Take into account the industry has a
whole, and the company’s place in it.
4. Debt-to-Equity Ratio
All companies carry a debt on the balance sheet. Even the richest companies carry liabilities.
However, you want to be wary of companies with high amounts of debt. Look at the company’s
balance sheet, and compare the debt-to-equity ratio. You want a company that has more assets
than liabilities. If you want an investment that is likely to present a lower risk, consider a
company with a debt-to-equity ratio of 0.30 or below. You can look into companies with higher
ratios if you have a little bit higher risk tolerance, or if a higher ratio is acceptable in the industry
(construction companies, for example, are known for higher ratios, since they use a lot of debt
funding).
5. Price-to-Earnings Ratio
Consider how well the stock’s price is doing in relation to its earnings. The P/E ratio is often
considered one of the most important considerations when it comes to fundamental analysis, and
value investing. This ratio looks at the company’s current price, and compares it to the per-share
earnings of the company. You figure the P/E ratio as follows: Take the current share price and
divide it by the earnings per share. So, if a company is trading at $40 per share, and the earnings
per share are $2.50, the P/E ratio is 16. Understand that the higher the P/E ratio, the greater the
expectation that there will be higher growth in the future. While you don’t want to rely entirely
on this factor, it can be helpful in comparing a company to others in the same industry.
6. Management
How well is the company managed? Do you feel that those in charge are competent? What is the
general culture? Is the company is innovative? Also, consider whether or not scandal could harm
the company. Keep in mind, too, that some scandals only harm the company in the short-term. If
the company is likely to recover from the setback, you can get a really good deal on the share
price in the midst of such difficulties.
7. Dividends
A company that pays dividends is often one with a certain amount of stability. However, be wary
of companies with very high yields. That can be an indication of coming instability.
Additionally, a company that pays a lot in dividends might not be reinvesting in the company.
Look for companies that pay modest, but regular (and increasing) dividends over time.
Examining a Company's Liquidity before Investment
Before you invest your money in a company, it's important that you measure a few of the
company's key financial metrics. To evaluate a company's finances, there are three financial
statements that you must carefully examine:
Balance sheet
Income statement
Cash flow
The best place to start when evaluating a company is looking for liquidity on the balance sheet in
cash form. Essentially, you're looking to see if the company has enough money to cover their
expenses. You should also be checking to see if the company's short-term debts will cause them
to exhaust their cash before the year's end.
To determine a company's liquidity on the balance sheet, you need to look for something called a
current ratio, which is a measurement of the working capital that the company possesses. You
can calculate the current ratio of a company, comparing its current assets that can be turned into
cash and its current liabilities that must be paid in the upcoming year. Ideally, a company will
have a 2:1 ratio of assets to liabilities.
Some companies can have a lower ratio if they are well run, meaning that they are effectively
controlling your cash. Companies in slow-growth industries also may not need as much liquidity
as companies in rapidly growing industries. Most companies, however, should have a 2:1 ratio.
Checking the Income Statement
After you've determined a company's liquidity, you should move on to the income statement.
This document will include several financial metrics that can help you decide whether to invest
in a company. In particular, you need to check the growth of earnings and the growth of net
income.
Checking these metrics can help you to determine if the company is actually growing. Look at
the bottom and top lines of the income statement going back 10 years. Do the numbers on the top
line continue to grow over those 10 years? Preferably, the top and bottom growth lines will be
parallel.
When these lines are parallel, it means that both the sales growth rate and the net earnings
growth rate are rising at the same rate. If the lines are not parallel, it may mean that the
company's earnings are growing while revenue is going down.
Examine Return on Assets
The next financial metric that you need to examine is the company's return on assets. There are
three different measurements that you can check to determine what a company is accomplishing
with its earnings compared to how much the company is spending to bring in those earnings:
Return on assets
Return on equity
Return on capital
Companies worth investing in will have strong returns. Generally, a good company will have a
30 percent return annually. Examining a company's return on assets will reveal its profitability,
as well as how effective the company is at using its assets to bring in revenue.
Don't Forget Operating Cash Flow
The fourth and final factor that you should examine before investing in a company is operating
cash flow, which you can find on the cash flow statement. Looking at this metric will help you to
discover if the company is generating real cash. You need to determine exactly how the company
is generating cash. Does the cash come from borrowing money and selling of stock and business
assets? If so, then putting your money into this business is likely not a wise investment.
On the cash flow statement, you need to look for operating cash flow. Subtract the money that
the company used to purchase equipment, known as capital expenses, from the operating cash
flow. What's left is the company's real cash flow. Basically, real cash flow is the money that can
either be reinvested into the company or paid to the company's owner. This money is important,
as it speaks to a company's ability to grow. You want to see real money coming in on the
operating cash flow line.
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