By David Adonri, Executive Vice Chairman, Highcap Securities

Amidst several investment opportunities, investors are often faced with difficulties in identifying the best investment choices. Arriving at a decision is an arduous task, but it can be simplified if from the beginning, the investor has certain investment goals in mind. Goals are tied to the differentiated needs of each individual. One investor may be investing to finance children’s education in future while another may be doing so for retirement.

Goals setting gives direction to an investment plan but peculiarities of the investor determines which pathway to follow in the investment journey. Profile of the investor in terms of demography, type of investor (retail or institutional), capital available for investment, duration of investment and risk tolerance level, establishes the background for congruence between goals and circumstances of the investor. 

Investment goals which are underpinned by the investor’s profile can only be translated from dream into reality when investment decisions are taken to identify the assets that are appropriate in type, volume and cost which can fulfill the goals. The process of identifying these assets and combining them so as to maximize the investor’s expected returns within an appropriate level of risk exposure, requires rigorous investment analysis. 

The construction and eventual management of an investment portfolio is based on sound investment analysis. This helps in the formulation of an overall investment strategy that conforms with the investor’s risk appetite. The aim of investment analysis is to determine how assets in an investment portfolio are likely to perform and how well they fit into a particular investor’s plan. Investment analysis can involve evaluating an investment strategy, the investor’s needs and financial situation, how the investment portfolio performed and whether it’s time for correction or adjustment. It can include using historical data to forecast future performance, selecting the type of assets that best suits an investor’s need or evaluating individual securities to determine their risks, yield potential and price movement. Political changes and socioeconomic conditions of the investment environment have a huge impact on the risks and returns of an investment. Their analysis is also required to assess such impact and to time the purchase or sale of assets in an effort to take advantage of systematic irregularities. 

There are two major types of investment analysis. These are “fundamental analysis” and “technical analysis”.

Fundamental analysis seeks to examine the state of a security issuer’s fundamental affairs, to know if it fits into an investor’s plan. The parameters to be examined centers around the issuer’s financial health, management competence, growth prospects, industrial harmony, competitiveness, regulatory framework and unsystematic risks profile. From historical data, the earnings per share and dividend yield over time can be computed to see if its profitability and consistency of dividend payment qualify it to be part of the investment portfolio. The net asset value will show whether the security of the issuer has intrinsic value or not (selling below or above its book value). Fundamental analysis can also seek out stocks that the market has mis-priced. That is, they are trading at prices lower than is warranted by their intrinsic value. Also, through fundamental analysis, one can uncover price sensitive information that can guide investment decision making. 

Analysis of corporate fundamentals is a “Bottom-Up” method of analyzing a company’s financial soundness, future business prospects and dividend potentials. Bottom-Up analysis takes a microeconomic approach to investing. It aims to find out the best company and securities based on their individual merit, valuation and pricing power. It determines whether the company will be suitable as a satisfactory investment. 

Fundamental analysis is also a tool for determining the eligibility of a debt security when selecting assets for an investment portfolio. It can provide vital fundamental information about the financial soundness and risk profile of a public or corporate issuer that will make the investment satisfactory. The rating of a debt issuer arising from fundamental analysis is designed to help investors understand the inherent risks in a debt security and hence empower the investor to seek an appropriate return.

The fundamental analyst stresses the financial health of issuers (companies and governments) as well as the broader socio-economic outlook. Unlike analysis of fundamentals of an issuer which is Bottom-Up, a “Top-Down” approach is adopted in analyzing the economy, market and industry trends before drilling down to the investment assets that will benefit from those trends. Assessment of historical data and forecasts of macroeconomic direction and public policies can help in understanding how markets and industries will be impacted now and in future. Now that the world is a global village, the fundamental analyst is expected to think globally while acting locally. Fundamentals of the global economy can no longer be neglected considering the contagion effects of the 2007 global meltdown, the 2020 COVID-19 pandemic and recent Ukraine war economic disruptions. Every market where assets are bought and sold has its fundamentals. The demand and supply patterns over time can be studied to identify trends as they affect price movements. This can serve as background for projections and planning. In descending the ladder from markets, the peculiarities of an industry can affect enterprises that operate in it. The seasonality of agriculture for instance is a peculiarity of the agric industry. This is further differentiated into annuals and perennials. An investment strategy must take these differences into consideration. The prospects of an entire industry can even become visible when fundamental analysis shows a huge supply gap that enterprises in the industry can advantageously explore to build wealth in the long term. Nigeria’s electric power industry for instance has over 90% supply gap which investors can tap into. 

The second type of investment analysis is “technical analysis”. This analytical method is market based. It evaluates the pattern of asset prices using statistical parameters and models to forecast future outcomes. In technical analysis, charts and graphs are employed in establishing patterns of price movements or trends, trading signals, year high and low prices, all with a view to figuring out when to enter or exit an investment. From a market perspective, technical analysis can provide vital information on the contribution of capital gain to overall profit of an investment and hence the payback period and its internal rate of return. Various analytical charting tools used to evaluate a security’s strength or weakness can aid in assessing its profitability and liquidity and thus ascertain if it satisfies the expected returns and risk appetite of an investor.

Investment analysis is research based. It requires access to socioeconomic and financial information, analytical tools and expertise, and devotion of time. As complicated as it seems, it is not beyond the competence of any retail investor because modern information and communication technology has placed the requirements within the reach of everybody. Therefore, the fact that effective investment analysis is a condition precedent to sound investment decisions, means that every investor who is undertaking an investment venture or planning to invest, ought to be armed with modern techniques of investment analysis.