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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.

Risk mitigation refers to the process of planning and developing methods and options to reduce threats or risks to project objectives. A project team might implement risk mitigation strategies to identify, monitor and evaluate risks and consequences inherent to completing a specific project, such as new product creation. Risk mitigation also includes the actions put into place to deal with issues and effects of those issues regarding a project.

Strategies:

1. Risk Acceptance: Risk acceptance comes down to “risking it.” It’s coming to terms that the risk exists and there is nothing you will do to mitigate or change it. Instead, it understands the probability of it happening and accepting the consequences that may occur. This is the best strategy when risk is small or unlikely to happen. It makes sense to adopt risk when the cost of mitigating or avoiding it will be higher than merely accepting it and leaving it to chance.
2. Risk Avoidance: If a risk from starting a project, launching a product, moving your business, etc. is too large to accept, it may be better to avoid it. In this case, risk avoidance means not performing that activity that causes the risk. Managing risk in this way is most like how people address personal risks. While some people are more risk-loving and others are more risk-averse, everyone has a tipping point at which things become just too risky and not worth attempting.
3. Risk Mitigation: When risks are evaluated, some risks are better not to avoid or accept. In this instance, risk mitigation is explored. Risk mitigation refers to the processes and methods of controlling risk. When you identify risk and its probability, you can allocate resources for management.
4. Risk Reduction: Businesses can assign a level at which risk is acceptable, which is called the residual risk level. Risk reduction is the most common strategy because there is usually a way to at least reduce risk. It involves taking countermeasures to decrease the impact of consequences. For example, one form of risk reduction is risk transfer, like that of buying insurance.
5. Risk Transfer: As mentioned, risk transfer involves moving the risk to another third party or entity. Risk transfers can be outsourced, moved to an insurance agency, or given to a new entity as is what happens when leasing property. Risk transfers don’t always result in lower costs. Instead, a risk transfer is the best option when it can be used to reduce future damage. So, insurance can cost money, but it may end up being more cost-effective than having the risk occur and being solely responsible for reparations.

Risk Evaluation

Identification: First and foremost, you must identify and define the types of risks that your business faces. There are both internal and external risks. When identifying risks, consider if they are preventable, such as operational risks, or not avoidable like natural disasters.

Impact assessment: Once you have identified risk, you can estimate their impact. This involves defining the probability that a risk will occur and its respective result or consequence.

Develop strategies: Finally, you can determine the necessary strategy for those risks that are likely to happen with medium or high probability. While you may still want to monitor low risks, they are less of a priority when it comes to taking the next step and making a plan.

The method of calculating break-even point of a single product company has been discussed in the break-even point analysis article. A multi-product company means a company that sells two or more products. The procedure of computing break-even point of a multi-product company is a little more complicated than that of a single product company.

The determination of the break-even point in CVP analysis is easy once the variable and fixed components of costs have been determined.

A problem arises when the company sells more than one type of product. Break-even analysis may be performed for each type of product if fixed costs are determined separately for each product.

However, fixed costs are normally incurred for all the products hence a need to compute for the composite or multi-product break-even point.

In computing for the multi-product break-even point, the weighted average unit contribution margin and weighted average contribution margin ratio are used.

BEP in units  = Total fixed costs / Weighted average CM per unit

BEP in dollars = Total fixed costs / Weighted average CM ratio

The weighted average selling price is worked out as follows:

(Sale price of product A × Sales percentage of product A) + (Sale price of product B × Sale percentage of product B) + (Sale price of product C × Sales percentage of product C) + …….

and the weighted average variable expenses are worked out as follows:

(Variable expenses of product A × Sales percentage of product A) + (Variable expenses of product B × Variable expenses of product B) + (Variable expenses of product C × Sales percentage of product C) + …….

When weighted average variable expenses per unit are subtracted from the weighted average selling price per unit, we get weighted average contribution margin per unit. Therefore, the above formula can also be written as follows:

Breakeven Point = Total fixed expenses / Weighted average contribution margin per Unit