Due diligence is an investigation or audit of a potential investment to confirm all facts, such as reviewing all financial records, plus anything else deemed material. Due diligence refers to the care a reasonable person should take before entering into an agreement or a financial transaction with another party. When sellers perform a due diligence analysis on buyers, items that may be considered are the buyer’s ability to purchase, as well as other elements that would affect the acquired entity or the seller after the sale has been completed.
An individual investor performs due diligence by studying annual reports, Securities and Exchange Commission (SEC) filings and other relevant information about a business and its securities. An investor verifies the material facts related to purchasing the investment and determines whether it fits his return requirements, risk tolerance, income needs and asset allocation goals. For example, an investor may read the company’s last two annual reports, several recent 10-Qs, and any independent research available. He can then develop a sense of where the business is heading, what market factors may affect the stock’s price and how volatile the stock is. The investor then has guidance on whether the investment is right for him, and how much and when to purchase it.