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Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In
finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of ...
, the purpose of investing is to generate a return from the invested asset. The return may consist of a gain (profit) or a loss realized from the sale of a property or an investment, unrealized
capital appreciation Capital appreciation is an increase in the price or value of assets. It may refer to appreciation of company stocks or bonds held by an investor, an increase in land valuation, or other upward revaluation of fixed assets. Capital appreciation ...
(or depreciation), or investment income such as
dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-i ...
s, interest, or rental income, or a combination of capital gain and income. The return may also include currency gains or losses due to changes in the foreign currency exchange rates.
Investor An investor is a person who allocates financial capital with the expectation of a future return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Typ ...
s generally expect higher
returns Return may refer to: In business, economics, and finance * Return on investment (ROI), the financial gain after an expense. * Rate of return, the financial term for the profit or loss derived from an investment * Tax return, a blank document or ...
from riskier investments. When a low-risk investment is made, the return is also generally low. Similarly, high risk comes with a chance of high losses. Investors, particularly novices, are often advised to diversify their
portfolio Portfolio may refer to: Objects * Portfolio (briefcase), a type of briefcase Collections * Portfolio (finance), a collection of assets held by an institution or a private individual * Artist's portfolio, a sample of an artist's work or a ...
. Diversification has the statistical effect of reducing overall risk.


Investment and risk

An investor may bear a
risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environme ...
of loss of some or all of their capital invested. Investment differs from
arbitrage In economics and finance, arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more markets; striking a combination of matching deals to capitalise on the difference, the profit being the difference between th ...
, in which profit is generated without investing capital or bearing risk.
Saving Saving is income not spent, or deferred consumption. Methods of saving include putting money aside in, for example, a deposit account, a pension account, an investment fund, or as cash. Saving also involves reducing expenditures, such as recur ...
s bear the (normally remote) risk that the financial provider may default. Foreign currency savings also bear
foreign exchange risk Foreign exchange risk (also known as FX risk, exchange rate risk or currency risk) is a financial risk that exists when a financial transaction is denominated in a currency other than the domestic currency of the company. The exchange risk arises ...
: if the currency of a savings account differs from the account holder's home currency, then there is the risk that the exchange rate between the two currencies will move unfavourably so that the value of the savings account decreases, measured in the account holder's home currency. Even investing in tangible assets like property has its risk. And just like with most risk, property buyers can seek to mitigate any potential risk by taking out mortgage and by borrowing at a lower loan to security ratio. In contrast with savings, investments tend to carry more risk, in the form of both a wider variety of risk factors and a greater level of uncertainty. Industry to industry volatility is more or less of a risk depending. In
biotechnology Biotechnology is the integration of natural sciences and engineering sciences in order to achieve the application of organisms, cells, parts thereof and molecular analogues for products and services. The term ''biotechnology'' was first used b ...
, for example, investors look for big profits on companies that have small market capitalizations but can be worth hundreds of millions quite quickly. The risk is high because approximately 90% of biotechnology products researched do not make it to market due to regulations and the complex demands within pharmacology as the average prescription drug takes 10 years and US$2.5 billion worth of capital.


History

The Code of Hammurabi (around 1700 BC) provided a legal framework for investment, establishing a means for the pledge of collateral by codifying debtor and creditor rights in regard to pledged land. Punishments for breaking financial obligations were not as severe as those for crimes involving injury or death. In the medieval Islamic world, the qirad was a major financial instrument. This was an arrangement between one or more investors and an agent where the investors entrusted capital to an agent who then traded with it in hopes of making a profit. Both parties then received a previously settled portion of the profit, though the agent was not liable for any losses. Many will notice that the ''qirad'' is similar to the institution of the commenda later used in western Europe, though whether the qirad transformed into the ''commenda'' or the two institutions evolved independently cannot be stated with certainty. In the early 1900s, purchasers of stocks, bonds, and other securities were described in media, academia, and commerce as speculators. Since the
Wall Street crash of 1929 The Wall Street Crash of 1929, also known as the Great Crash, was a major American stock market crash that occurred in the autumn of 1929. It started in September and ended late in October, when share prices on the New York Stock Exchange colla ...
, and particularly by the 1950s, the term investment had come to denote the more conservative end of the securities spectrum, while speculation was applied by financial brokers and their advertising agencies to higher risk securities much in vogue at that time. Since the last half of the 20th century, the terms speculation and speculator have specifically referred to higher risk ventures.


Investment strategies


Value Investing

A value investor buys assets that they believe to be undervalued (and sells overvalued ones). To identify undervalued securities, a value investor uses analysis of the financial reports of the issuer to evaluate the security. Value investors employ accounting ratios, such as
earnings per share Earnings per share (EPS) is the monetary value of earnings per outstanding share of common stock for a company. It is a key measure of corporate profitability and is commonly used to price stocks. In the United States, the Financial Accountin ...
and sales growth, to identify securities trading at prices below their worth.
Warren Buffett Warren Edward Buffett ( ; born August 30, 1930) is an American business magnate, investor, and philanthropist. He is currently the chairman and CEO of Berkshire Hathaway. He is one of the most successful investors in the world and has a net ...
and
Benjamin Graham Benjamin Graham (; né Grossbaum; May 9, 1894 – September 21, 1976) was a British-born American economist, professor and investor. He is widely known as the "father of value investing", and wrote two of the founding texts in neoclassical inve ...
are notable examples of value investors. Graham and Dodd's seminal work, ''Security Analysis'', was written in the wake of the
Wall Street Crash of 1929 The Wall Street Crash of 1929, also known as the Great Crash, was a major American stock market crash that occurred in the autumn of 1929. It started in September and ended late in October, when share prices on the New York Stock Exchange colla ...
. The
price to earnings ratio A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the ...
(P/E), or earnings multiple, is a particularly significant and recognized fundamental ratio, with a function of dividing the share price of the stock, by its earnings per share. This will provide the value representing the sum investors are prepared to expend for each dollar of company earnings. This ratio is an important aspect, due to its capacity as measurement for the comparison of valuations of various companies. A stock with a lower P/E ratio will cost less per share than one with a higher P/E, taking into account the same level of
financial Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fi ...
performance; therefore, it essentially means a low P/E is the preferred option. An instance in which the price to earnings ratio has a lesser significance is when companies in different industries are compared. For example, although it is reasonable for a telecommunications stock to show a P/E in the low teens, in the case of hi-tech stock, a P/E in the 40s range is not unusual. When making comparisons, the P/E ratio can give you a refined view of a particular stock valuation. For investors paying for each dollar of a company's earnings, the P/E ratio is a significant indicator, but the
price-to-book ratio The price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company's current market value to its book value (where ''book value'' is the value of all assets minus liabilities owned by a company). The calculation can be performed i ...
(P/B) is also a reliable indication of how much investors are willing to spend on each dollar of company assets. In the process of the P/B ratio, the share price of a stock is divided by its net assets; any intangibles, such as goodwill, are not taken into account. It is a crucial factor of the price-to-book ratio, due to it indicating the actual payment for tangible assets and not the more difficult valuation of intangibles. Accordingly, the P/B could be considered a comparatively conservative metric.


Growth Investing

Growth investors seek investments they believe are likely to have higher earnings or greater value in the future. To identify such stocks, growth investors often evaluate measures of current stock value as well as predictions of future financial performance. Growth investors seek profits through
capital appreciation Capital appreciation is an increase in the price or value of assets. It may refer to appreciation of company stocks or bonds held by an investor, an increase in land valuation, or other upward revaluation of fixed assets. Capital appreciation ...
– the gains earned when a stock is sold at a higher price than what it was purchased for. The price-to-earnings (P/E) multiple is also used for this type of investment; growth stock are likely to have a P/E higher than others in its industry. According to Investopedia author Troy Segal and U.S. Department of State Fulbright fintech research awardee Julius Mansa, growth investing is best suited for investors who prefer relatively shorter investment horizons, higher risks, and aren’t seeking immediate cash flow through dividends. Some investors attribute the introduction of the growth investing strategy to investment banker Thomas Rowe Price Jr., who tested and popularized the method in 1950 by introducing his mutual fund, the T. Rowe Price Growth Stock Fund. Price asserted that investors could reap high returns by “investing in companies that are well-managed in fertile fields.”


Momentum Investing

Momentum investors generally seek to buy stocks that are currently experiencing a short-term uptrend, and they usually sell them once this momentum starts to decrease. Stocks or
securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
purchased for momentum investing are often characterized by demonstrating consistently high returns for the past three to twelve months. However, in a
bear market A market trend is a perceived tendency of financial markets to move in a particular direction over time. Analysts classify these trends as ''secular'' for long time-frames, ''primary'' for medium time-frames, and ''secondary'' for short time-fram ...
, momentum investing also involves short-selling securities of stocks that are experiencing a downward trend, because it is believed that these stocks will continue to decrease in value. Essentially, momentum investing generally relies on the principle that a consistently up-trending stock will continue to grow, while a consistently down-trending stock will continue to fall. Economists and financial analysts have not reached a consensus on the effectiveness of using the momentum investing strategy. Rather than evaluating a company’s operational performance, momentum investors instead utilize trend lines, moving averages, and the Average Directional Index (ADX) to determine the existence and strength of trends.


Dollar-Cost Averaging

Dollar-cost averaging (DCA), also known in the UK as pound-cost averaging, is the process of consistently investing a certain amount of money across regular increments of time, and the method can be used in conjunction with value investing, growth investing, momentum investing, or other strategies. For example, an investor who practices dollar-cost averaging could choose to invest $200 a month for the next 3 years, regardless of the share price of their preferred stock(s),
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV ...
s, or exchange-traded funds. Many investors believe that dollar-cost averaging helps minimize short-term volatility by spreading risk out across time intervals and avoiding market timing. Research also shows that DCA can help reduce the total average cost per share in an investment because the method enables the purchase of more shares when their price is lower, and less shares when the price is higher. However, dollar-cost averaging is also generally characterized by more brokerage fees, which could decrease an investor’s overall returns. The term “dollar-cost averaging” is believed to have first been coined in 1949 by economist and author Benjamin Graham in his book, '' The Intelligent Investor.'' Graham asserted that investors that use DCA are “likely to end up with a satisfactory overall price for all
heir Inheritance is the practice of receiving private property, titles, debts, entitlements, privileges, rights, and obligations upon the death of an individual. The rules of inheritance differ among societies and have changed over time. Officiall ...
holdings.”


Intermediaries and collective investments

Investments are often made indirectly through
intermediary An intermediary (or go-between) is a third party that offers intermediation services between two parties, which involves conveying messages between principals in a dispute, preventing direct contact and potential escalation of the issue. In la ...
financial institutions. These intermediaries include
pension fund A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme which provides retirement income. Pension funds typically have large amounts of money to invest and are the major investors in listed and priva ...
s,
bank A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets. Because ...
s, and insurance companies. They may pool money received from a number of individual end investors into funds such as
investment trust An investment trust is a form of investment fund found mostly in the United Kingdom and Japan. Investment trusts are constituted as public limited companies and are therefore closed ended since the fund managers cannot redeem or create shares. ...
s,
unit trust A unit trust is a form of collective investment constituted under a trust deed. A unit trust pools investors' money into a single fund, which is managed by a fund manager. Unit trusts offer access to a wide range of investments, and depending o ...
s, and
SICAV A SICAV is a collective investment scheme common in Western Europe, especially Luxembourg, Switzerland, Italy, Spain, Belgium, Malta, France, and the Czech Republic. SICAV is an acronym in French for ''société d'investissement à capital varia ...
s to make large-scale investments. Each individual investor holds an indirect or direct claim on the assets purchased, subject to charges levied by the intermediary, which may be large and varied. Approaches to investment sometimes referred to in marketing of collective investments include
dollar cost averaging Dollar cost averaging (DCA) is an investment strategy that aims to apply value investing principles to regular investment. The term was first coined by Benjamin Graham in his book '' The Intelligent Investor''. Graham writes that dollar cost avera ...
and
market timing Market timing is the strategy of making buying or selling decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting fro ...
.


Famous investors

Investors An investor is a person who allocates financial capital with the expectation of a future return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Typ ...
famous for their success include
Warren Buffett Warren Edward Buffett ( ; born August 30, 1930) is an American business magnate, investor, and philanthropist. He is currently the chairman and CEO of Berkshire Hathaway. He is one of the most successful investors in the world and has a net ...
. In the March 2013 edition of '' Forbes'' magazine, Warren Buffett ranked number 2 in their
Forbes 400 The ''Forbes'' 400 or 400 Richest Americans is a list published by '' Forbes'' magazine of the wealthiest 400 American citizens who own assets in the U.S., ranked by net worth. The 400 was started by Malcolm Forbes in 1982 and the list is ...
list. Buffett has advised in numerous articles and interviews that a good investment strategy is long-term and
due diligence Due diligence is the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or contract with another party or an act with a certain standard of care. It can be a l ...
is the key to investing in the right assets. Edward O. Thorp was a highly successful
hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as sho ...
manager in the 1970s and 1980s who spoke of a similar approach. The investment principles of both of these investors have points in common with the Kelly criterion for money management. Numerous interactive calculators which use the Kelly criterion can be found online.


Investment valuation

Free cash flow measures the cash a company generates which is available to its debt and equity investors, after allowing for reinvestment in
working capital Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
and
capital expenditure Capital expenditure or capital expense (capex or CAPEX) is the money an organization or corporate entity spends to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land. It is considered a capital expenditure ...
. High and rising free cash flow, therefore, tend to make a company more attractive to investors. The debt-to-equity ratio is an indicator of capital structure. A high proportion of
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
, reflected in a high debt-to-equity ratio, tends to make a company's earnings, free cash flow, and ultimately the returns to its investors, riskier or volatile. Investors compare a company's debt-to-equity ratio with those of other companies in the same industry, and examine trends in debt-to-equity ratios and free cashflow.


See also

* Divestment * Asset *
Capital accumulation Capital accumulation is the dynamic that motivates the pursuit of profit, involving the investment of money or any financial asset with the goal of increasing the initial monetary value of said asset as a financial return whether in the form ...
*
Capital gains tax A capital gains tax (CGT) is the tax on profits realized on the sale of a non-inventory asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, real estate, and property. Not all countries impose a c ...
* Climate-related asset stranding *
Diversification (finance) In finance, diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. A common path towards diversification is to reduce risk or volatility by investing in a variety of assets. I ...
* EBITDA *
Financial risk Financial risk is any of various types of risk associated with financing, including financial transactions that include company loans in risk of default. Often it is understood to include only downside risk, meaning the potential for financial ...
*
Foreign direct investment A foreign direct investment (FDI) is an investment in the form of a controlling ownership in a business in one country by an entity based in another country. It is thus distinguished from a foreign portfolio investment by a notion of direct c ...
*
Fundamental analysis Fundamental analysis, in accounting and finance, is the analysis of a business's financial statements (usually to analyze the business's assets, liabilities, and earnings); health; and competitors and markets. It also considers the overall sta ...
* Fundamental Analysis Software *
Hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as sho ...
* Legal Alpha * List of countries by gross fixed investment as percentage of GDP *
List of economics topics The following outline is provided as an overview of and topical guide to economics: Economics – analyzes the production, distribution, and consumption of goods and services. It aims to explain how economies work and how economic agen ...
* Market sentiment * Mortgage investment corporation *
Rate of return In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment, such as interest payments, coupons, c ...
*
Socially responsible investing Socially responsible investing (SRI), social investment, sustainable socially conscious, "green" or ethical investing, is any investment strategy which seeks to consider both financial return and social/environmental good to bring about socia ...
* Specialized investment fund * Time value of money * Time-weighted return *
Mutual Fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV ...


References


External links

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