How to Identify an Investment Opportunity

One of the greatest challenges to profitable investing is the ability to sort through thousands of options to find suitable and attractive investment opportunities. The techniques to evaluate and assess an investment vary from asset class to asset class. You need to clearly understand the fundamentals used to evaluate the particular type of investment under consideration.

Evaluate the price of an investment to understand its value, whether it qualifies as a bargain or whether it appears fairly-priced or over-priced, based on known risks and market conditions. For stocks, one valuable tool is to compare the price-to-earnings ratio for an individual security to other stocks within that sector, determining if it is relatively cheap. When looking at real estate investments, on the other hand, the comparison should be made to recently-sold properties in the same area to determine relative value. In addition, for real estate, it may be helpful to look at historical trends to find properties that seem cheap compared to historical levels. For bonds and other asset classes, it also can be helpful to look at historical prices for each sector to locate the best bargains within that space. Be sure to run Internet searches for any relevant information about specific companies or market trends.

After narrowing your possible targets, analyze profit potential and possible risks in greater detail. Based on the most reasonable outlook rather than rosy assumptions, determine the most-likely forecast for the particular investment. This requires evaluating basic fundamentals. For stocks, you need to look at operating profit margins, overall revenue or sales growth, growth in net earnings after business costs, free cash flow and return on equity. For real estate, among many variables you will need to determine the potential for growth in a specific area based on the outlook for population trends and any plans for future construction. For bonds and other asset classes, you will need to analyze the outlook for interest rates as well as the likelihood of future inflationary pressures. With bonds, it is critical to understand that interest rates and bond value move in opposite directions. When interest rates rise, the underlying value of the bond declines, while a bond's value rises if interest rates decline. Most analysts monitor the Federal Open Market Committee or FOMC of the U.S. Federal Reserve to forecast interest rates.

After studying the fundamentals for individual stocks, mutual funds, bonds, real estate or other investments, create a risk-to-reward profile for the selected investment opportunity. Based on all available input, make a decision whether the investment's potential reward outweighs likely risks, taking into account your own risk tolerance.