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There are two good reasons for learning how to analyze potential investments. Firstly, you may want to invest yourself. Secondly, the process can teach you a lot about business. This knowledge could help you improve an existing business or start a new one. With that in mind, here are some tips on how to analyze potential investments.

Focus on fundamentals, not jargon

Every sector has its jargon and investment is no exception. If you read literature intended for experienced investors then you’ll find it full of terms you probably don’t know, GIPS consulting, P/E ratios, EBITDA. These can look intimidating if you see them on their own. Most of the time, however, they’ll be obvious in context. If not, they’re easily found on the internet.

All these terms, and the others you’ll see, are just convenient shorthand ways to describe a company’s way of operating and its performance. A quick glance through them will often be enough to give an experienced investor an idea of whether or not a company is worth further investigation. It is, however, very unwise to rely solely on headline facts.

Always look below the surface

Headline figures will tell you what a company is doing but not how it is doing it. You, therefore, need to look deeper to see if the company’s performance is the result of luck or strategy. Usually, the best place to start your research is with the company’s annual shareholder report.  

This will typically contain both its financial information and broader information about the company. Reading through the financials will give you the hard facts about the company’s performance. This may answer some questions you may have but it may also raise others. For example, the financials may list one-off expenses but not fully explain what they are.

That’s why you generally need to read through the full shareholder report. It should give a full explanation of any key points in the financials. It should also alert you to anything else that could influence the value of the company. For example, if any senior managers are due to move on, the company should advise how they are going to be replaced.

Ideally, you’ll look at filings over at least three years, preferably at least five. This will give you an idea of how the company has performed over time. Has it been consistent? If not, is there a clear explanation of inconsistencies? Cross-reference any points of interest in the shareholder reports with external news sources.

Never underestimate the importance of management

Anybody can have a great idea but it takes a lot more than just a great idea to build a successful and sustainable company. It takes strategy. In business, that effectively means working with the legacy of the past and positioning the company to go into the future. That’s the role of management.

For this reason, your analysis of a potential investment should always end with a close look at its management. Some companies will include biographies of their managers and these can be a good starting point. In general, however, you want to spread your net wider. Look at their entries on social media, (especially LinkedIn) and also check for news stories about them.

As a rule of thumb, it’s best to avoid investing in a company if you have any doubts about its management or concerns about management changes. The only possible exception would be if the stock was very attractively priced and there were strong indications that the situation was likely to be resolved.