Investment appraisal for dummies!

Many people come to me with all sorts of deals. Some promise to double my money every 2 weeks! But how should a layman without any fancy education in Finance make such decisions intelligently?

Fortunately there is a whole profession dedicated to the subject of financial analysis. These people are sometimes called Certified Financial Analysts (CFA). The good news is you don’t have to be a CFA to make intelligent investment decisions.

I will suggest seven decision criteria you can apply to any venture to ensure you don’t lose your money and maximize your return as well.

First you need to understand what you are investing in. It is no good investing in trees if you have no idea how a tree grows! You would rather keep your money under a mattress. Luckily with the internet and the free universities of Google and YouTube you can learn anything. Then seek out local people who have already done what you intend to do and visit their projects. My wife and I visited many successful farmers before venturing into agriculture.

Second does the deal seem too good to be true? If it is you are most likely going to lose your money. Many people have lost money in all sorts of ponzi or pyramid schemes. If it seems to good to be true run for your dear life.

Third. What is the motive for investing? Is it for regular income or capital appreciation? For example if you want regular income then you can’t buy land. Because land if not developed is just an idle investment and you only get your money back once you sell the land. If you want regular income then you can invest in a small retail business or rentals, etc.

Fourth. What are the expected returns or profits. Profit is income less expenses. The profit figure has to be compared with the capital you injected in. Say you spend UGX 100m in a business venture and you make 15m in profit at the end of the year then your return on investment is 15%. This return should be higher than what you would get on a risk free investment like Treasury bills to justify the additional risks you are taking on.

Fifth. What is the risk involved? Personally I don’t like taking on too much risk. If the deal keeps you awake throughout the night you may need to reconsider. If you are mortgaging your family home to raise capital for a hot deal you are most likely going to regret this decision. Risk management is a whole subject on its own. There are four generic ways to manage risk (the 4Ts). You can Treat or control the risk. For example vaccinating chicken is a way to manage the risk of fatalities on your chicken project. Setting up an irrigation scheme on your coffee plantation is a way to manage the risk of drought. You can also treat risk by diversifying your projects. Have at least 3 different projects you are investing in at anyone moment. You can Transfer or share the risk. For example you can insure your fleet of trucks in your transport business. You can Tolerate or accept risk like risks of political instability which you can’t really control. You can also Terminate or avoid the risk by simply not engaging in the deal. For example I avoid the risk of ponzi schemes by simply not participating in such deals.

Sixth. What is the Payback period? When do I get my money back? Is it one month, 1 year, 2 years? It all depends on what your motivation for investing is. For instance my wife and I have invested in a pine forest with a payback of 15 years. This project is basically a retirement project and higher education for our daughters. The longer the payback period the higher the risk involved.

Seventh. Is it fun? Investment is risky and stressful business so make sure you have lots of fun doing it. The people you are dealing with should be fun to hang around. I don’t want to be a rich gloomy fella!

So there you have it. Seven decision criteria you can apply to any investment to take the guess work out.
1. Understand what you are investing in.
2. Does it seem too good to be true?
3. What is the motive for investing?
4. What are the expected returns or profits?
5. What is the risk involved?
6. What is the payback period?
7. Make sure you have fun!

A lot of research has gone into the above mentioned decision criteria. Comment below to let us know how you have applied some of this criteria to your investments. Or simply share your experience in the comments below for the benefit of other people.