Last Updated on January 17, 2023 by Administrator
If there’s a golden rule in investment it’s that “if you wait to see others profiting before you invest in something, you’re already late.” This is because by the time early investors begin to see profits, the prospects or opportunities for later investors often diminishes or even in some cases reverses into losses.
It’s easy for anyone to see and say, when something is already yielding profits, that “this is indeed a good investment let’s get in too,” but that is often when the opportunity is already exhausted. Like trying to invest in a tree at harvest, it raises peculiar questions and risks for any investor which we’ll get to in a bit.
The trick for a true investor is in being able to forecast and anticipate correctly the profitability of a venture ahead of time – foresight, that’s where the core skill is.
Foresight may be gained either by intuition or perceptiveness about the market in general, which is often a more natural inclination, or via empirical approaches in fundamental or technical analyses among others used by professionals and investment bankers.
Different approaches or analyses suit different times and areas of investment.
One may gain foresight about an investment through:
1. An Understanding of the Item and Market
Intuition or perceptiveness about an item and market in question is the foremost approach to gaining foresight. Intuition here is backed by some logical chain of thought or analyses rather than an arbitrary hunch. This approach is however tricky for many who do not have such an inclination in the first place, and is therefore dangerous to advise others to take due to the risk and money involved. Generally with this approach one looks to answer the following questions about an item to decide if it’s a good investment or not:
- Is it something of value? That is;
- In satisfying a need, desire or interest, or
- As something someone else might be interested in in future for any reason
- How rare or common is it or its direct alternatives?
- To whom (in terms of kinds and number of people) will this be of value?
- How capable will the owners or promoters be in offering or selling this value?
- What would others have to expend (financially, emotionally or otherwise) to have this value, and would they?
- How long will it remain valuable (asking the above 5 questions into the future)?
…be it a business, product, commodity or some security or financial instrument; answers to these and related considerations would tell if something is a good investment or not.
Inasmuch as the associated risk for such analyses is incredibly high for most people, being heavily based on assumptions and knowledge about the market, if the underlying assumptions are indeed correct, the subsequent reward can be enormous for an investor.
Market research is sometimes used to answer the above questions as a check against risky assumptions in such analyses, but the effectiveness of such research might still be in question since it relies on the accuracy of answers provided by respondents in such research, answers which may differ from actual behavioural patterns of same respondents. Other unaccounted or unpredicted market factors may also affect the reliability of said research.
2. Financial Analyses
Empirical approaches such as fundamental and technical analyses are favoured more by professionals as they offer proof or performance-based and data-centric analyses for investment decisions.
Either way, neither approach completely eliminates risk; it is the nature of economics that markets are not exactly predictable even with trend data. The ideal thing is to recognise the different risk levels presented by each approach and area of investment; and as is well known in investment, the higher the risk the greater the reward.
How Foresight Works
During Seed Investment
This is where intuition and perceptiveness about an item and market helps most in gaining foresight about the worth of an investment, prior to any “proof” or performance. While this stage also presents significant risk, a bet placed here if successful yields the biggest possible wins to any investor owing to their foresight; granting them the most astronomical gains or returns on the smallest investment made, over the course of investment.
For example Peter Thiel invested $500,000 in Facebook in 2004 for about 10% stake in the company, and that’s as a later seed investor; Eduardo Saverin, a cofounder, held between 24% – 10% stake in the company around 2004/05 having invested a few 1000s of dollars earlier too. While a simplistic analogy, with 10% of Facebook (now Meta) worth about $34 billion in Jan 2023 (down from close to $100 billion just the previous year) it’s easy to see how those who make the long forecast into the future of an investment win the most.
Those who invest at the start of planting a seed (idea) stand to be the biggest all-time winners. Whether a tree will grow > fruit > feed depends on the questions asked.
During Venture Capital Investment
By the time a company gets to this stage they are already growing or earning profits. This therefore means that, if a company still needs money to expand, the company has significantly higher capital needs (far more than what its profits or revenues can support) and thus the value of money to the company is significantly lowered. In other words you’d need to be a high-net-worth investor or corporate investor with huge sums of money to get even a small portion of such a company.
This is where later investors are already disadvantaged compared to earlier (seed) investors; they would need to invest significantly more for less share of the company, albeit with more reliable expectations per the company’s financials which some look or wait for.
When venture capital comes in at this stage of growth/success, seed investors are the real winners. Venture capitals can only hope for continued and future success.
Here fundamental analysis (a study of a company’s financial statements and key metrics or business and industry data) is used to gauge the current and future profitability of a company; whether it has a future in which company’s value shoots up culminating in an IPO or favourable exit strategy and therefore whether to invest in it now or not.
And here, even then, investment isn’t 100% risk free because a company’s financials do not account for new potential, tastes, technology, entrants and other market factors which are always changing. One might also note that some companies here at this stage or much later in their public stage reach the height of their ingenuity and lack the ability to generate or invent new and refreshing ideas (even though they may still have market dominance and resources) and/or begin to see internal diseconomies of scale (experiencing a more than proportionate increase in overhead etc.) as they expand.
For these reasons a good understanding of the market again as explained early on, in addition to fundamental analysis, helps to gain better foresight about the worth of an investment/company going into the next future.
Companies are generally seen to be successful when they file for an Initial Public Offering (IPO) which represents the most “assured” stage of company financials, profits or growth potential, when the general public as well as institutional investors are invited to partake in its investment for even greater, say national or international, expansion.
Again at this stage, venture capitals and other early investors who correctly predicted this stage for the company early on in the previous stages are the winners, as the value of their investment would have shot up again astronomically.
When stock investors and investment banks come in during an IPO, existing investors are the real winners. New investors can only hope and invest toward continued and future success.
In Long Term Stock Investment
Stock investors are essentially the last to cash in on the success of a company, even though even so it helps to be an early stock investor. Here an investor may still employ fundamental and other analyses, as well as an understanding of the item and market again, to gain foresight about the worth of an investment or company moving into the next future.
People who invested $1,000 in Apple in January 2006 after the release of its MacBook Pro or say in 2007 after the launch of Apple TV and the iPhone, would have shares worth about $65,000 in November 2022; a staggering 400% annual appreciation on average, without even adding dividend payments made to shareholders through that time.
If one invests in Apple now however, as many may be tempted to, it shouldn’t be because of current earnings, that opportunity is already exhausted. It should be based on foresight about the company moving into the next say 5-10+ years, since that is what one would be investing for.
Many tech stocks including Facebook and Apple’s have fallen considerably toward the end of 2022 after reaching incredible heights in 2021 and early 2022; if one were tempted to invest by the rise in 2021, they’d have “lost” close of 2022.
In Trading Operations and Other Investments
Even with day trading where people invest in stocks or related assets to reap gains in the short term (based on day to day rise and fall in stock values), it still helps to have foresight.
As Matthew Krantz and Robert R. Johnson PhD, CFA, CAIA note in their book ‘Investment Banking for Dummies’ investment banks keep their trading strategies secret because “one of the greatest downsides of proprietary trading is that when other investors get wind of the strategy and start to copy it, the strategy doesn’t work anymore.” As a simple example they explain further, say, if one noticed that stocks rise in value every early January, then they could simply buy stocks late December for cheap and wait for the magic to happen in January; and then sell after that for profit. But if everyone found this out, everyone would now buy stocks late December, and since demand would then rise at that time late December so would the price of stocks same time, and then early January rather when everyone already has these stocks and no one to sell to, the value would drop, creating a loss for all.
It highlights how whatever valuable (or money-making) system you have, once it becomes popular and attracts copy acts, it effectively loses its power.
Technical analysis (a study of the movement of share price and volumes in the stock market) is a primary method of predicting and placing bets on investments at this stage. With trading, the factors that influence the value of a stock or security are innumerable and is highly based on speculation; it’s practically a gamble with other players in the market, quite volatile but also rewarding for those who can and like to play.
Either way, even here, early investors who catch wind of any impending drop or rise in stock value before it sets in, win. Those who come in after a sustained rise, can often expect a stock value to stagnate or drop thereafter in the short-term; although again these markets can be full of surprises.
This applies to most forms of trading be it stock, cryptocurrencies or NFTs and other forms of day or short-term trading or investments.
Final Remarks, Scope and Limitations
Generally, one must be cautious about an investment when everyone is now running to it because it’s earning; given that if a system were capable of making everyone rich it would invariably be unable to, just as if everyone could be special, no one then would. The trick is in staying ahead and doing what not many are doing yet, as long as it’s prudent and checks out in one’s initial analyses.
These notes mostly cover investments such as in companies and stocks but also apply in some areas to investments in general such as in art, technologies, properties, commodities, currencies, economies, etc.
The exceptions are fixed income investments which have constant returns and thus no special periods of profit or not, and in some cases mutual funds, which pool various investments into one.
It is also important to remember that investments, no matter where, always carry some level of risk and therefore if you can, never put all your eggs in one basket.
These notes apply to genuine and legitimate investments. There are a number of quack schemes and scams in the market that look like and claim to be “investments” but are not, and one must be careful to avoid those; they are as dangerous, sometimes even more so, to early participants as late ones. Unfortunately, the variety of quack money-making schemes and scams are too many to touch on how to tell legitimate ones from scams in this article. If one is not savvy enough to tell them apart, it’s best to stick to investments that are duly regulated by their government.
Ps. This is an opinion piece by an entrepreneur and investor Fuseini Yakubu