INVESTMENT ANALYSIS - (Concept of Investment )

INVESTMENT ANALYSIS

Topic: Concept of Investment

Hi guys, let’s do some theories – you never can tell, most students  concentrate on calculations and on the judgment day, simple theory will put them off;

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INTRODUCTION

Economist view investment as an addition to fixed capital stock or the value of an economic output at any given point in time that takes the form of new investment, new structure, new production, change in inventory in whatever form.  It should be noted that in economics, there are two types of investment namely; 

a.       Social Investment

b.      Economic Investment

Social investment is undertaken to improve the well being or the welfare of the citizens as such, no profit or return is expected from such venture.

Economic Investment is undertaken primarily for profit marking.  For the purpose of this lecture, economic investment will be the bone of contention.

Financial analyst view of investment: Financial analyst define investment as the act of committing resources into an undertaken with the hope of reaping returns in the future.  In this context, financial scholars see investment as the commitment of funds into an undertaken with an expectation of positive return commensurate with the level of risk assumed.

DISTINGUISHING BETWEEN INVESTMENT, GAMBLING AND SPECULATION

PARAMETERS	INVESTMENT	SPECULATION	GAMBLING
Time horizon	The length of time between the date investment is made and the future date when it is relinquished or sold is usually more than 1 year.  The time horizon for investment is a long period of time – sometime commitment of funds.	The holding period for any form of speculation is usually less than 1year.  It could be 2 weeks or 1 month or 5 months but less than a year.	The holding period of gambling can be measured in seconds.

Planning horizon	An investor has relatively longer planning horizon of at least one year.  Before investing a feasibility study is conducted to determine whether or not the investment will generate adequate cash-flow and profit, withstand the risk it will encounter and remain viable in the long-term.	A speculator has a short planning horizon – usually few days or few months.  In the actual sense, most speculators have no time for feasibility study or do not conduct F.S.  All they do is identify and buy sellable asset in expectation of profit from market fluctuate or with the hope of selling them when t he price appreciate.	Gambling has absolutely no planning horizon.  The Gambler does not do the kind of search; investigation, analysis, scrutiny or evaluation that is supposed to precede any rational investment activities.
Risk disposition	An investor is normally not willing to assume more than moderate risk, meaning that an investor is not willing to assume risk more than the expected return	A speculator is ordinarily willing to assume high risk.	Highly risky. A gambler takes on risk that is greater commensurate with the expected returns.  He assumes higher risk.
Return expectation	An investor usually seeks a modest rate of return which is commensurate with the limited risk assumed by him.	A speculator looks for a high rate of return in exchange for the high risk borne by him.	A gambler expects higher returns.
Basis for decision	An investor attaches greater significance to fundamental factors and attempts a careful evaluation of the prospects of the firm.	A speculator relies more on hear say (rumour) and market psychology to forecast what the future market will be like.  If he expects price increase, he commits his funds.	The basis  for his decision is the outcome i.e. the return.

CHARACTERISTICS OF GOOD INVESTMENT

A good investment has the following characteristics:

a.       REASONABLE INCOME: For any investment to be considered good enough, such an investment must be capable of yielding reasonable return relative to the size of the fund invested.  In other words, proportional to the cost of investment.

b.      MARKETABILITY:              A good investment must be highly marketable in the sense that it can be readily bought and sold.

c.       LIQUIDITY:          Any good investment must be highly liquid.  This refers to the degree of ease in which such an investment can be converted into cash without any significant loss or value.

 

d.      STABILITY OF INCOME:  A good investment should be capable of yielding or generating income on continuous basis.  It needs not to be constant in terms of amount, but it should be regular.

THE INVESTMENT PROCESS OR PORTFOLIO MANAGEMENT PROCESS

The investment process describes how an investor should go about making decisions with regards to what marketable securities to invest in, how extensive the investment should be, and when the investment should be made.

There are five steps in the investment process:

i.                     Setting Investment Policy

ii.                   Performs Security Analysis

iii.                  Constructs a Portfolio

iv.                 Revise the Portfolio

v.                   Evaluate the performance of the portfolio

Setting Investment Policy:

This is the investment planning stage where the investor defines his mission statement as well as his risk tolerance level.  He also determines his investment objectives at this stage as well as his asset mix.

Perform Security Analysis:

Performing security analysis involves examining several individual security market prices in an attempt to predict future price movement.

Portfolio Construction:

Portfolio construction involves identifying those specific assets in which to invest as well as determine the proportions of the investor’s wealth to put into each one.

Portfolio Revision:

Portfolio revision concerns the periodic repetition of the three previous steps.  Revising a security is necessary because over time, the prices of the security changes, meaning that some securities that initially where not attractive may become attractive and others that were attractive at one time may no longer be so.  Thus, the investor may want to add the former to his or her portfolio, while simultaneously deleting the latter.

Portfolio Performance Evaluation:

It involves determining periodically how the portfolio performed, in terms of not only the return earned but also risk experienced by the investor.