Comparison of investment analysis methods

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.

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 favorable.

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.