Investment analysis

What is Investment Analysis?

Investment analysis is a comprehensive term. As a result, it includes a wide variety of

calculations and assessments that analyze market trends, investments and financial
industries. Meanwhile, analysts may use a variety of metrics including past returns, yield
potential, price movement and more to help them make better investment decisions.

Types of Investment Analysis

With all the data and financial information available, there are a variety of methods
analysts and investors use. However, investment analysis can be divided into a few
different categories.

Bottom-Up

Bottom-up analysis assesses individual stocks by using their merits. For example, these
merits include pricing power, management competence and valuation. However, this
investment analysis method doesn’t focus on market or economic cycles to determine
asset allocations. Instead, this method looks at the best companies and stocks
regardless of the state of the economy and market.

In other words, bottom-up analysis has a more microeconomic or small-scale

perspective and approach instead of looking at the economy at large.

Top-Down

Top-Down analysis examines the economic, market and industry trends before making a
more specific investment decision. For instance, say an analyst evaluates different
industries and found that technologies outperformed financials. Consequently, they may
decide to allocate their portfolio with greater weight in financials than technologies. They
will then seek out the best-performing companies within the financial sector.

In comparison to a bottom-up analysis, an investor may find compelling reasons to

purchase a single technology stock and invest a significant amount of capital in the
stock. The investor may do this even if the overall outlook on the industry is poor.

Technical Analysis

Technical analysis focuses on finding patterns of stock price movements that’s

discovered through analysis of a security’s prices and volume of share trades.
While fundamental analysis focuses on the intrinsic value of a stock, the technical
analysis evaluates the strength or weakness of a security by reviewing a variety of
analytical charting tools, trading signals, and price movements.

For example, let’s say the average price of a share over a short period (50 days)
surpasses the moving average of a share price for a longer period (200 days) technical
analysts might see a buying opportunity. Conversely, if a stock’s 50-day moving average
price falls below its 200-day moving average, technical analysts might see an
opportunity to sell.

Keep in mind technical analysis focuses on the actual price of the stock, not the financial
strength of the company or industry or economy. Essentially, if you use technical
analysis, you’re assuming pricing history already reflects all important information.
Fundamental Analysis

Fundamental analysis focuses around the idea that at any given time a company’s
shares have an intrinsic or enterprise value, which the market will acknowledge
eventually. To identify this value, the investor must observe the corporation’s financial
performance. However, fundamental analysts also assess the state of that firm’s industry
and overall economic health.

Fundamental analysts use metrics including earnings-per-share (EPS), dividend

yield, price-earnings (P/E) ratio, and return on equity to determine the corporation’s
value. This method also focuses on a company’s assets, liabilities, and expenses.

Analysts will closely examine the firm’s reports which are filed with the Securities and
Exchange Commission. These reports may include the 10-K and 10-Q, as well as sell-
side analysts’ reports on the company.

Fundamental Analysis Details

Now that you understand the big picture of how fundamental analysts determine a
company’s value, let’s take a deeper dive into some of the metrics that make up this
examination. Keep in mind, some investors may solely rely on each individual metric to
make an investment decision.

Price-Earnings Ratio (P/E)

A price-earnings ratio shows the correlation between the price of one share of a stock
and the earnings-per-share that the company reports over a period. This period is
generally one year. It illustrates the amount of money each investor is putting into the
firm for every dollar of earnings the company posts.

You can calculate the P/E ratio by dividing the stock’s market value per share. Often,
investors will compare one stock’s P/E to other stock’s P/E in the same industry to
determine the value of the stocks. Usually, investors consider lower P/E ratios
favourable.
Earnings Per Share

Earnings per share indicates how efficiently revenues filters down to investors. To
calculate a company’s earnings-per-share investors should take earnings remaining for
shareholders divided by the number of outstanding shares. If a company has high
earnings per share, investors may identify them as a profitable firm.

Book Value

Investors may use the price-to-book ratio to identify high-growth companies that are
undervalued. While the book value of a company is the total number of assets minus
total liabilities, you can calculate the P/B by taking the market price of a company’s stock
and dividing by the book value of equity. If a company has a low P/B ratio, it’s viewed as
undervalued.

Dividend Yield

The dividend yield is the relationship between a company’s dividend payments and stock
price. To calculate the dividend yield you will divide the annual dividend by the current
stock price. You can then compare one company’s dividend yield to another. Investors
may select companies with higher dividend yields if they are seeking to invest in
companies with high dividend payments.

Return on Equity (ROE)

Essentially, the return on equity (ROE) reveals the company’s efficiency at turning
shareholder investments into profits. ROE takes the net income from a firms’ income
statement and the shareholders’ equity from its balance sheet. Therefore, if a company
liquidates its assets to pay off debt, ROE is the amount that’s left over for shareholders.

To calculate the ROE, divide a company’s net income by its shareholder equity. The
higher ROE a company has the better.
The Bottom Line

Selecting the wrong investment opportunity can end up costing you your entire
investment or more. While selecting the correct investment opportunity has the potential
to help you achieve unlimited gains. Using an investment analysis method can help you
make a better and more educated decision.

There are plenty of methods of investment analysis to asses an investment opportunity.

Including different valuations into your analysis may help you make a better investment
decision. The more information and data you can use, the better the evaluation you may
be able to achieve.

Investment Tips

 Consider talking to a financial advisor about how investment analysis could

improve your investment decisions. Finding the right financial advisor who fits
your needs doesn’t have to be hard.
 Don’t assume that your investment strategy needs to depend exclusively on one
kind of analysis. You may find that technical analysis works better in some
situations while fundamental analysis works better in other situations.