Understanding whether or not an asset is likely to grow in value usually means figuring out three things:
- Are there intrinsic reasons for the asset to grow?
- Is the external environment conducive to growth?
- Are other investors likely to be interested in the future?
Now let’s break each of these down.
Are there intrinsic reasons for the asset to grow?
All assets – companies, commodities, collectibles, digital assets, precious metals, debt, and real estate all have their own unique ways of demonstrating promise. It’s up to the investor to figure out if the opportunity in front of them holds these characteristics.
When evaluating a company, for example, the goal is to understand how well positioned it is to return profits to shareholders in the future. We can discern this by asking questions:
- Is it currently in a competitive position?
- Is it likely to conquer new market share?
- Is it likely to preserve its margins at the same time?
When it comes to commodities or property, different factors need to be considered – the location, the quality, and of course – is there rising demand for what it offers?
Is the external environment conducive to growth?
Unstable market conditions affect even the most stable companies or sought-after real estate.
Cases like rapidly rising inflation, economic downturns, and market liquidity crises (situations in which there is a large gap between the price buyers will pay and sellers will accept), will all impact an asset’s potential future value.
Are other investors likely to be interested in the future?
An asset’s price typically reflects people’s expectations. An example is a recurring phenomenon we see called bubbles. Bubbles (and the crashes that follow them) are simply a reflection of many people overestimating an asset’s likely returns, then realizing the need to correct their expectations. This was the case for Tulips in 17th century Holland, internet-based businesses in 1999, and American mortgages in 2008.
This means it’s critical to analyze how you think other investors will view the asset in the years to come. To understand the power of this analysis, consider this: Imagine that you’re considering buying stock in a company that ticks the first two boxes (it has intrinsic value and exists in an environment conducive to growth). Well, if it’s already valued at a high price relative to the rest of the market, there’s a chance that the asset hasn’t got much more room to grow.
At the other end of the spectrum – if it feels like it’s only you who sees potential in the asset – its price is low and it’s not getting much attention – do you see yourself being able to convince others that it’s a gem?
Performing your assessment takes time
As tedious as it may seem, conducting a thorough analysis of an investment opportunity is time well spent. The investor’s quickest road to ruin is often ignoring the research process and instead either replicating what has worked for others in the past or buying into the opportunity that is currently grabbing the most attention (see the section above on bubbles!).
Whenever you’re tempted to skip the research, remember the fact that most stocks lose value. A handful of stocks have been responsible for virtually all the gains in the stock market since 1926. This means due diligence and diversification are an investor’s best friends.
With a clear understanding of the research process, you’re ready for the next step: building your own investment strategy. Head to our next article, here, to continue.