How is an investment portfolio constructed? Part 4
In the last 3 deliveries (part 1, part 2 y part 3) on this topic, we have elaborated on the objectives of a portfolio, the particular considerations of savers and finally landed on the selection of investments starting with regions, countries, sectors and finally companies. This approach from the most to the least or from the top to the bottom. "top down approach"is the traditional or classic process of analysis. This process has been refined by introducing new concepts and analytical tools that have allowed for a more complex approach. However, there is no better approach to guide a new investor or any interested party to the disciplines of investment analysis, selection, execution and monitoring.
Having in the final paper Having briefly described the country analysis, and the rudiments of a business sector analysis, we will then move on to elaborate on the analysis of companies or institutions and from there to the analysis of investment instruments.
It is important to raise "prima fascie"All business opportunities begin with an analysis of the business, its competitive situation and its ability to generate positive results. These factors are reflected in the company's financial situation. In other words, in a first round of analysis, the companies or issuers of investable securities must meet general criteria of financial and business health. It is very difficult for a company to be attractive as an investment, either by acquiring its shares or buying its debt securities, if its vital numbers do not look good. That said, depending on the amount and nature of the instruments offered to the investor, there will always be a second round of analysis more focused on the instruments themselves.
To better explain specifically the above, let's examine some scenarios. There are many companies, profitable and well managed, but at the same time very attached to their traditional business, such as banks. Normally, good banks offer debt securities or deposits, safe, with good guarantees and interest payable to the depositor or holder of their bonds, a return commensurate with that performance.
But at the same time, in general terms, banks' equity securities, i.e. their shares, do not offer the rapid growth prospects that a technology company can offer. True, they are more conservative investments, but they are not the type of instruments that usually make up a portfolio that seeks growth rather than income.
However, in order to rationally conclude this possible dichotomy, it is necessary to analyze both sides of the institution. A bank is not always a non-innovative institution without opportunities for rapid growth. In a good analysis of the institution's numbers and reports, it is possible to see how and in what it invests to grow or to consolidate. For example, it dedicates resources to technology in order to migrate to a digital environment with lower operating and expansion costs.
An opposite example would be investments in technology. There, the risks of development, innovation and competition are high and at the same time, their funding needs being high, they cannot pay the high interest rates that a debt security issued at that level of risk must pay. What does exist in these types of companies are capital needs whose growth potential is the major factor of interest for investors. Here, much of the traditional financial analysis does not apply. Many of these companies do not make money, even though they have a positive cash flow. So in these cases, there are other criteria and metrics to weigh the risk return on these investments.
To try to summarize, it would be unthinkable to invest in a bank that does not make money, but it is not unreasonable to do so for a company in innovative sectors. Only, going back to the first part of the catechism, investing in equities in new and innovative sectors is not the type of investment that should dominate the investments of a granny who lives on the dividends of her investments.
Returning to the initial thread, we must concentrate on a meticulous and recurrent analysis of the issuer's conditions, whether companies or institutions, in order to at least in that first cut know in depth the strengths and weaknesses of that structure. That is enough for much more than this article.
In addition, we must analyze the specific metrics that underpin the instruments. There is an old market saying that a good company does not necessarily translate into a good stock for investors. And vice versa. There are stocks that are very popular and widely bought by investors whose price is much better than their actual financial performance. Just as there are companies with stellar financial performance but which do not entice the public to pay much for them.
This is where that analysis beyond the numbers, ratios and percentages reconciles, the financials, with the prospects that buyers and sellers in the real life, marketplace.
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