Investors must go through many available investment options to identify a potentially profitable investment opportunity. Identifying an investment opportunity requires researching the current value of an investment and determining the probability of the value rising in the future. The associated risks of an investment also help to identify investment opportunities. Understanding how to value an investment and identify risks may help you find those investments most likely to yield solid returns.
Many investors choose to look at a company’s financial statements to determine the financial health and earnings power of the firm. A company’s price-to-earnings ratio reveals its earning power. This information is useful when comparing one company with its peers. If the P/E ratio of a company whose stock you are considering is 15 and the P/E ratios of key competitors are 20, the investment may be undervalued. High P/E stocks are generally riskier than low P/E stocks. Well-established companies typically have low P/E ratios, but they also represent less risk. New companies and growth stocks typically carry a high P/E. They possibly offer higher returns, but the risk of losing money may also be high.
Identifying an investment opportunity includes determining the risks associated with a particular investment. Risks are categorized as systematic and nonsystematic. Systematic risk deals with factors that affect the overall economy and all companies, regardless of their financial health. Common systematic risks include liquidity, inflation, interest rate, currency and sociopolitical risks. To combat systematic risks, investors choose to include in their portfolios a variety of investments that react differently to systematic risks. Nonsystematic risk is the risk related to investing in a particular industry, company or product. Management risk and credit risk are the two types that fall under nonsystematic risk.
Investment opportunities depend greatly on your risk tolerance. Investment opportunities of a conservative risk-taker differ from those of an individual who is comfortable taking risks. Factors that typically affect an investor's risk tolerance include age, financial goals, the timeline to meet goals, financial obligations and financial resources. Most people consider age as the top determining factor. Younger investors can typically afford to take more risks than older investors because they have more time to gain back any losses. Regardless of age, investors should properly research investment opportunities before making decisions.
Making a Decision
Each investment you research needs a profile chart comparing the value of the investment to the associated risk. Identifying an investment opportunity includes deciding if the value of the investment outweighs the risk. You must also take into account your level of risk tolerance. If the value and profitability potential outweigh all risks, you should pursue the investment opportunity. Even after making a decision to invest, you must monitor the investment’s performance to determine the length of time to remain invested.
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