Sep 22, 2022

Identifying & Analyzing Sound Investments

— Once you understand the basics of investment, a typical next step is identifying sound financial securities, investments which will yield the best returns, long or short term.

4 minutes

By ODP

Did you know that ‘less than 3 percent of the [Nigerian] population invests in the formal financial markets’?  


The prevalent reason for this low percentage is that these individuals view investments as unattainable, either in terms of financial literacy or the hurdle of ‘you need money to make money’. So, if you have gotten past these hindrances or are just gathering more information to get started on your exciting and rewarding process of investment, welcome to the next stage. 


Investing is not a game of trying out anything to see what sticks or buying into popular market trends; it is about strategic moves that yield returns. Once you understand the basics of investment, a typical next step is identifying sound financial securities, investments which will yield the best returns, long or short term. While you might not require professional level skills to identify sound financial instruments, it is possible to choose investments like a pro. 


First, a ‘good investment’ is subjective – based on the investor’s financial goals, time horizon and risk appetite. With these factors, the investor bases his investment success on what best fits his own financial goals. On the other hand, a ‘sound investment’ is a more generalized variation of a good investment. Sound investment refers to those financial instruments that are a good opportunity to amass returns and are secure, regardless of the investor’s risk appetite or goals.  


A sound investment is typically: 


Fairly valued 


Diversified 


Relatively liquid 


Generates income 


Expected to increase in intrinsic value over time 


Regulated or protected by standard policies 


A good investment is also one which the investor has a good understanding of the instruments as well as the risks. 


 

When presented with several investment options, below are methods through which these options can be weighed and selected. 


 

Top-Down Method 


Take a moment to think about the ‘from top to bottom’ trend and what the phrase means. 


The term ‘top-down’ not only hints at looking at the ‘big picture’ but also a hierarchical process. That is, whatever happens at the top (global financial market) will trickle down to affect the littler details (specifics of the financial instrument). Beyond the intricate details of the financial market, there are overshadowing macroeconomic factors that can dictate asset performance.  


An investor who uses this method would analyze individual assets within specific sectors, by examining how they are affected by factors like the broad (global/local) economy, inflation, GDP, geopolitical risks, taxation and the financial market itself.  


One major downside to applying this method is that it is quite a generalized approach and thus, the investor could potentially miss out on investment opportunities that do not seem particularly compatible with government policies or economic trends. 



Bottom-Up Method 


From the term, it is easy to deduce that the bottom-up method implies the reverse of the top-down approach. 


This method starts with the analysis of the specific components and metrics of individual financial assets. Some of the details of the asset which the investor might consider include the earnings, valuations, pricing power and overall performance within the market. 


The bottom-up analytic method can be disadvantageous because it focuses on the specificities of the individual assets. Because the investor is focused on the specificities of the individual assets, he might miss opportunities or suffer losses that are brought on by macroeconomic or market trends.  


 

Technical Analysis 


Besides the above investment analysis methods, technical analysis is made based on historic market trends, such as price movements and trading volume.  


The technical analyst is interested in objectively tracking market trends to draw out patterns or indicators from past or present market performers, which are then used as a benchmark for judging the individual asset. For the most part, the technical analysis of financial assets is focused emphatically on price movements. 


Most times, technical analysis can be made automated, so that, based on the metrics, signals are sent to the investor to buy or sell assets. Its reliance on data and non-nuanced details can be a disadvantage to this approach, because flawed data or even user bias can lead to false buy/sell signals. 


 

It is essential to have a basic knowledge of how to identify and examine investment options which can bring you closer to your financial goals, with the most profitable results. It gives you better insight into what you are investing in, whether you do it personally or via an asset manager. So, what analytic would you like to try? 


If you are looking for a team of experts trained in the different methodologies of financial analysis, asset management and stockbroking, click here

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