When you choose an investment, you want it to make you as much money as possible. Careful investment appraisal lets you figure out which opportunities are a great deal and which ones you should avoid like the plague. Investment appraisal gives you a realistic sense of the potential risks and rewards.
The first step in investment appraisal is to look at the probable outcomes if you buy into a particular company. Your friend's plans for his new start-up, for instance, may sound exciting, but appraising the odds of success and the possibility of failure gives you a better idea of the potential. List the potential outcomes and identify the most successful result you can realistically expect. If it's not enough to satisfy you, the investment is one you should pass up.
If you think an investment has sufficient odds for success, appraise the financial returns. When you compare the benefits of two or three possible investments: If they all look like winners, the decision may come down to which of them offers the best return. Depending on your financial plans, your priority may be whichever investment offers the quickest return or gives you the highest annual rate of return.
A good appraisal considers the risks of things going wrong. If the company's is fighting a patent infringement lawsuit, ask what happens if the company loses. If corporate strategy is built around the patents, that may raise the level of risk higher than you can accept. Other uncertainty factors include snagging a government contract, a land deal falling through or the possibility some of the company's key staff might move on. If the risks are high, they may outweigh the potential rewards.
Investing isn't just about money. A good appraisal considers intangibles such as your reputation, your peace of mind and your personal principles as well. If you're committed to investing only in companies that pay a living wage, investing in a company employing sweatshop labor may make you richer, but also unhappy. If your image matters to you, choose investments that won't cause a scandal.