You have finally decided to plan for the future. You have earmarked funds for investment. You are likely to consider different investment avenues like mutual funds, shares, bonds, money market accounts or other investment options as well. Like any other typical investor, your primary investment objective is to obtain/earn profit, return on investment or income. But, how do you analyze and decide asset allocation? Investment Valuation can guide in making informed decisions about what to buy or sell.
It is the valuation of investments that help in determining whether a particular investment is a prudent, intelligent, worthwhile investment. It is an established fact that equity assets in comparison to debt assets provide growth and hedge against inflation. Drafting an ideal portfolio involves management of funds between both categories in line with your investment objective and the tolerance level for risk.
Investment decision-making process
Before investing, consider these vital points and find appropriate answers. This will be a useful exercise in selecting the right investment product to meet your financial goal.
- The amount of money you want to invest
- Purpose of investment
- Time frame/duration of investment
- Return you expect to achieve
- The extent of risk you are willing to tolerate
- The tax consequences of relevant investments
- The impact of inflation.
Short-term investment options include savings account, money-market funds and certificate of deposits. Incomes from short-term investment can be pre-determined with relevance to duration of investment. This hardly requires an assiduous investment valuation. However a discerning long-term investment plan in bonds, stocks or mutual funds call for investment valuation.
Mutual Fund: Net asset value or NAV of a particular mutual fund indicates the performance of that specific scheme. NAV is subject to daily changes and should be calculated end of each business day. Use these simple steps to calculate NAV per unit of a mutual fund.
- Take the current market value of the fund's net assets (total assets minus liabilities)
- Divide by the total number of shares issued
The unit reflects your, i.e. the prospective investor's share in the respective fund. Therefore, when you decide to buy, you pay the current NAV per share, plus any sales charge (otherwise termed as sales load). When the NAV appreciates, and you are interested in selling the shares, the fund will pay you NAV less any other sales load.
Shares: As you proceed to evaluate shares, compare companies of the same industry type. Earnings per share or EPS help you decide shares investment. The EPS also helps in comparing and evaluating between companies X and Y. Use these simple steps in calculating EPV.
- Take the net earnings of the company
- Divide by the outstanding number of shares.
EPS: Denotes the net income or net profit that is available with the company after settling all its bills. The EPS is the amount that you as a prospective investor would get for each share that you own when the total profit is distributed amongst the company's shareholders. However, EPS does not reflect the assessment of the share by the market. Consider P/E ratio for market assessment of the share. It is possible to calculate to EPS this way.
- Take the net income of the company
- Subtract dividends on preferred stock, if any.
- Divide the amount by the outstanding number of shares.
P/E Ratio: Price to earning ratio helps to gauge the general trust or confidence the market has in the company's ability to grow. It directly highlights the connection between the price and recent performance of the company. Price to earning ratio shows the relationship between a stock price and its company's earnings (or profits) per share of stock. Calculate P/E ratio in the following manner:
- Note down the current market price per share of the company
- Divide market value per share by EPS.
Try to avoid investing in companies that have very low or high P/Es. It is best to buy stocks with a P/E of between 7 and 10. If you are looking to invest in insurance companies or commodity trading company or any other specialist company like investment trusts, do not consider the P/E ratio. It is the value of assets that will determine the investor's confidence.
Bonds: Par value, coupon rate and maturity date are the key factors for determining the yield of bond or the returns, always quoted as a percentage. The current yield refers to yield of the bond for a one-year period (until maturity). Try these steps to calculate current yield.
- Note down the coupon rate of the bond
- Divide coupon rate by the bond's current market price.
Other investment options: Considering the real estate market boom experienced worldwide, you are likely to come up with a worthwhile investment option. Estimating a property's current market value accurately helps in determining the profit aspect. How do you assess the market value of a property?
- The most probable price the property can fetch under current conditions
- Provided the buyer and seller are prudent and knowledgeable individuals
- And, the price should be unaffected by undue stimulus.
Ways to value real property: Market approach, cost approach and income approach are the three ways to value real estate properties.
Market approach: Compare the value of property with similar property sold in the same area. You can use this for valuing residential property, vacant land and farm properties.
Cost approach: Take into account labor costs and construction material prices that may be required to replace the existing structure with a similar one. Add this value to an estimate of the market value of the land. You can use this approach for valuing special purpose and utility properties.
Income approach: If it is an apartment building, store or a factory, analyze how much income the property can fetch, in case the property under consideration is rented. Take into consideration operating expenses, insurance costs, maintenance costs, terms related to finance also.
Investment valuation tool
Using investment valuation tools, your decision-making process becomes easier, quicker and simpler. Investment valuation tools (software) that comes along with expert instructions assist in making better, informed investment decisions. You can evaluate both fresh investments as well as amend existing investments. Required data should be input in a template to enable evaluating a wide range of investment scenarios.
The readymade spreadsheet can calculate NPV, EPS, virtually any type of valuation, be it for stocks, bonds or real estate. Specifically for real estate investments, make use of real estate valuation tool, software to make comparisons of properties. This kind of an analysis can assist in determining to buy or sell or just keep looking for properties.