How To Assess A Potential Investment In A Business For First Timers

Planning to invest in a business for the first time?

It can be a daunting prospect. On the one hand, it could be a lucrative opportunity to exponentially grow your investment and generate a good return. On the other hand, you face the risk that you could lose your money completely, if things don’t go as planned.

Ah, the investor’s dilemma…the eternal balancing act between potential risk and potential reward…

Don’t worry, help is at hand. While there is obviously no way to totally mitigate risk, here are some tips to help a new investor, evaluate the business opportunity in a more informed way. Using these methodologies, you might be able to discover some information that will at least better equip you to make a more informed decision before putting your hard-earned capital, into a business venture.

Firstly, we should understand that there are a range of factors that should be evaluated when assessing a business. Some are financial in nature, while some are non-financial in nature.

So what should we look for?

1. Look at the past performance of the company. This approach takes a historical perspective. Here, the financial statements are the “magic document”. All the info on past performance can be extracted from the numbers and from calculating some of the key ratios.

Generally, there are 4 key classes of ratios ie. liquidity, solvency, profitability and efficiency. Some of these key ratios are the current ratio, and debt-to-equity ratio, ROE (Return on Equity), ROI (Return on Investment), ROA (Return on Assets) and ROIC (Return on Invested Capital). It must be noted however that the level of insight a potential investor can glean from these ratios, depends very much on the nature of the business, the type of industry and other subjective factors.

2. Look at is how much money the company makes, and how much of that is turned into profit. Look at how the company performed last year, and compare with its performance this year. Also look back 3-5 years to spot trends. Is the Management of the company able to successfully convert revenue generated from business activities (such as sales of products/services) into profit?

Here, a couple of other ratios would be helpful in your assessment, such as gross margin (ratio of profit to sales), gross profit (sales minus COGS or cost of goods sold), net income margin (ratio of net income to sales) and operating margin (ratio of operating profits to sales). You could also look at the operating profit, which is derived from gross profit minus operating expenses, plus net income which equates to operating profit minus interest and tax.

3. Do some digging to find out more about the operations of the business. Are key operational components such as accounts receivable and inventory turnover being efficiently managed so as to optimise operations? This is a good way to assess how efficiently the current management is running the company. It allows you to spot potential flaws and weaknesses in the operations systems which could be negatively impacting the profitability of the business.

4. Due diligent with some key ratios which will help with your assessment here are efficiency ratios such as inventory turnover (ratio of cost of goods sold, to the inventory held by the business). If this ratio yields a high value, it means that inventory is efficiently converted into sales, and this is good news.

Another ratio to look at is the ratio of uncollected payments/sales on credit, to amounts paid by/received from the customer. Again, when the accounts receivable turnover is high, it means that the company is collecting its outstanding payments in a timely manner which is good for business.

To find out more about these and many other ratios and how to apply them to your assessment, just google any one of these ratios and a variety of free resources will guide you further.

What about non-financial metrics?

Taking a forward-looking perspective, you’ll want to get a gauge on how the business is likely to perform in future. To an extent, this is really the most important question, as the answer will determine whether you will lose money or make money on this venture!

But sadly, no crystal ball for you to gaze into here. No one can be 100% sure how a business will perform in the future, it’s pretty much guesswork and luck. But, there are some things to look out for which can help you with your evaluation.

Here’s where some industry/domain expertise would come in very useful:

i. If you are familiar with the business you’re investing in, your experience and domain knowledge will give you a keener insight into the details than someone who is going ahead only on the numbers without understanding the back story. Like everything else, domain expertise can be learnt even if you don’t already have it. Start reading up, researching, talking to people in the business. Use every available free (and if you have the means, paid) resource at your disposal to deepen your knowledge and understanding.

ii. In today’s fast-paced world, today’s incredible business success story could be tomorrow’s sad failure. Carry out a SWOT analysis on the industry to check out threats, risks and also opportunities, impacting the business. For links to some free SWOT analysis tools.

iii. Keep abreast of industry developments. Stay up to date with domestic and international business news. It’s also a good idea to do some comparison/benchmarking. Look at the performance of the company or business against that of its competitors in the industry. This should not be a challenge for companies in established/mature industries.

However, if you are thinking of investing in a startup, or in a company operating in a new or super high-tech space, you might not have easy access to comparison models. For such businesses at the cutting-edge of technology, you may need to look overseas to global markets for guidance.

Happy investing and wishing you all the very best in your investment decisions in 2015!

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EPF / KWSP Dividends for Year 2014: 6.75%

Employees Provident Fund (EPF / KWSP) has declared a dividend rate of 6.75% for 2014 with a total payout of RM36.66bil.

The Employees Provident Fund (EPF) Board, with the approval of the Minister of Finance, today announced a dividend rate of 6.75 per cent and RM39.08 billion gross investment income for financial year ended 31 December 2014, an increase of 11.66 per cent compared with RM35.00 billion in 2013.

The 6.75 per cent dividend amounted to a total payout of RM36.66 billion where RM5.41 billion was required to pay every one per cent of dividend rate for 2014. This was 10.53 per cent higher compared with RM4.91 billion paid for every one per cent dividend rate for 2013, in tandem with the rise in contributors’ savings.

In a statement today, EPF Chairman Tan Sri Samsudin Osman said, “Despite uncertainties in both the domestic and global markets, our result in 2014 outperformed what we had achieved in 2013. It is worth mentioning that our global investments had contributed 33 per cent towards our total income for 2014 despite being only 23 per cent of our total assets.

“No doubt the end of 2014 had been challenging for the EPF due to the slump in the global oil prices. The weakening of the ringgit in the fourth quarter added further uncertainty. However, our prudent diversification approach had given us the edge and resilience to weather the economic conditions, particularly in the global markets.”

He said in order to correspond with the Fund’s objectives to preserve and add value to members’ savings, the EPF aims to provide at least a return of two (2) per cent above inflation over a three-year rolling period. The dividend declared for 2014 is equivalent to a rolling three-year real return of 4.11 per cent over inflation.

The latest dividend payout was derived after deducting the net impairment allowance on financial assets, unrealised losses due to foreign exchange rate and derivatives prices, investment expenses, operating expenditures, statutory charges as well as dividend on withdrawals.

The 2014 gross investment income was mainly driven by Equities in the domestic and global markets covering both emerging and developed countries. The asset class recorded an investment income of RM22.91 billion in 2014, up 17.37 per cent compared with RM19.52 billion in 2013, and contributed 58.63 per cent to the total gross investment income in 2014. Almost half of the income of the equity investment is derived from EPF’s global portfolios.

The majority of the EPF’s investment assets were placed in low risk fixed income instruments as this asset class provided a stable stream of income in the long run.

Loans and Bonds contributed RM7.57 billion in income, compared with RM7.51 billion in 2013. This rise was attributed to the performance of the global portfolios by both internal and external fund managers. Malaysian Government Securities and Equivalents recorded RM6.59 billion in income, registering a rise of 6.14 per cent, compared with 2013. Meanwhile, Money Market Instruments posted an income of RM619.65 million.

Real Estate and Infrastructure contributed RM1.39 billion in investment income in 2014. This inflation-linked asset class, which the EPF has started invested in since 2010, has over the years been showing encouraging performance and is a 22.31 per cent increase from 2013.

Tan Sri Samsudin said these asset classes were effective inflation hedging tools, befitting the Fund’s long-term objectives as a retirement fund, and the EPF would continue to explore opportunities in real estate, infrastructure and natural resources in accordance with its Strategic Asset Allocation (SAA).

“We foresee the challenges ahead given the rising levels of economic uncertainty in both domestic and global markets on the back of low oil prices, potential reduction in global GDP growth and further compression in fixed income yields. Recent quantitative easing in global markets and a more deflationary outlook will lower expected nominal yields for long-term investors like the EPF. However, we expect inflation to remain benign given our aggregate demand and lower energy costs. With this in mind, this year will see us continue upholding our policy of judicious risk management and investment allocations that targets a return that beats the rate of inflation.

“The bulk of our investments is in the domestic market and although the breadth of investment products and liquidity to trade in large volumes are somewhat limited, we remain optimistic due to our local market’s strong fundamentals. Based on this premise, we will continue to tap into opportunities in the local market that fit into our risk-return profile. The bottom line for the EPF remains the real returns for our members and therefore, we will continue to be prudent, diversified and disciplined in our approach to investing.”

As at 31 December 2014, the EPF’s total investment assets stood at RM636.53 billion, up 7.91 per cent from RM589.87 billion in 2013. The overseas exposure, which makes up 23 per cent of the Fund’s total investment assets, is part of the diversification programme to generate consistent returns in the long-term.

Tan Sri Samsudin added, “Syukur Alhamdulillah, I am proud to say that the achievements recorded last year as well as the numerous awards won by the EPF were attributed to the hard work and commitment of our team to continually deliver to our members.”

Members can view the 2014 dividend announcement via EPF’s Facebook page at “Kumpulan Wang Simpanan Pekerja”, Twitter at KWSPBuzz and on YouTube at KWSP Malaysia.

The EPF account statement for the crediting of the 2014 dividend is available online via i-Akaun at myEPF website (www.kwsp.gov.my). Alternatively, members can obtain their statement via EPF Kiosks or visit any EPF branches starting Sunday, 8 February 2015.