Due diligence is critical when deciding which investment options to pursue. Investigate a promising investment to get all the facts. Review financial records, Securities and Exchange Commission filings, last two annual reports, and any available independent research.
Before purchasing any investment, you not only need to forecast a potential return on investment but also assess your own risk tolerance. You must also have a clear idea about your income needs and asset allocation goals.
Let’s say, you’ve been reading about Bitcoin and are conversant with many anecdotal reports of investors who have done well with this cryptocurrency as an investment. Your next step is to find a Bitcoin mining provider like Genesis Mining. When evaluating a provider study objective reviews before deciding to do business with them. This will give you a clear idea about the provider and the investment. If you decide that this is the right investment for you, then you have to figure out how many Bitcoins you want to buy and when you will purchase them.
A Brief History of Due Diligence
Sometimes it’s easier to understand something by looking at its history. This view of the origins and development can give us much more perspective.
Due diligence isn’t a whimsical idea by some astute investors. It’s a legal concept that arose in 1933 when formulating the U.S. Securities Act.
The concept was designed to make investing fair for all parties: investors and dealers or brokers alike.
Investors needed full disclosure from security dealers and brokers about an investment instrument they were selling. Without frank and comprehensive information sharing, it would be impossible to make a rational decision about whether or not to buy something. The Act stipulated that dealers and brokers who didn’t provide full disclosure risked criminal prosecution.
However, this made dealers and brokers vulnerable to investors who might use this Act as a basis for unfair prosecution should their investments not pan out as hoped. It was possible that dealers and brokers were not to blame – if they fell short of full disclosure because they did not know or possess a material fact prior to the sale. In order to protect dealers and brokers, the due diligence clause was added as a legal defense. In essence, if a dealer or broker did their due diligence on an equity they were selling and fully disclosed their investigations of the company to investors, they could not be held responsible.
The Due Diligence Process
Conducting due diligence is a rigorous process, as close to a scientific method as possible in the financial world. It is not a random investigation of pertinent records in the hope of making a discovery.
Here are the recommended 10 things to review, analyze, or evaluate an investment:
- 1. A company’s capitalization.
- 2. Revenue and profit, as well as margin trends.
- 3. Competitors in the industry and any ancillary industries.
- 4. Valuation.
- 5. Management and ownership of shares.
- 6. Balance sheets.
- 7. The history of stock prices.
- 8. Stock options and possibilities of dilution.
- 9. Expectations of performance.
- 10. Long and short term risks.
Why Due Diligence Can Fail
When the due diligence process fails, it’s rarely due to the process itself, but because it was not used or certain steps missed. This is why financial disasters like the failed AOL-Time Warner merger can happen.
In some financial markets, investors are so eager to not let a short-lived opportunity slip through their fingers that they use short-cuts. For instance, in FOREX trading, an investor may simply buy a position to see if it is profitable. If it looks good, they will add to it. If it doesn’t, then they close for a loss.
A System for Checks and Balance
The due diligence process is designed to help all parties involved in any investment. The idea of due diligence when properly executed by all parties is one of checks and balances. It’s an invaluable methodology to follow if you aspire to hit six figures or more in your bank account.
An investor should do due diligence on a dealer or broker to make sure that they are legitimate operators and have a good track record. In addition, they should also take a close look at the equity they plan on buying. For instance, if buying real estate after establishing that they are working with a reputable broker, they should still ask for all house inspection records to make sure that the property has no hidden problems like lead, asbestos, mold, etc. For their part, a dealer or broker needs to do due diligence on a company and the equities that they have agreed to sell.