Explore different investment analysis options and level-up your investment game.

A financial investment is any asset or instrument acquired to sell for a profit in the future (capital gains) or with the expectation that it would provide income directly (such as rental income or dividends). There are many distinct types of investments from a broad perspective.

A difficulty many investors have is choosing the right, profitable investment. Fortunately, investment research can assist investors in determining how an investment will perform.

The process of evaluating an investment for income, risk, and resale value (profitability) is known as investment analysis. Its ultimate goal is to determine whether a certain investment is a good fit for a portfolio, and is critical for anybody thinking about investing, regardless of the type. Risk, cash flows, and resale value are the three aspects that most investment analysis methodologies consider.

We take a quick look at some of the more popular investment analysis techniques that may assist you in making better investment decisions.

#1. Bottom-Up

Individual equities are evaluated based on their merits in bottom-up analysis. These merits include, for example, pricing power, management expertise, and valuation.

However, when determining asset allocations, this investment research method does not consider market or economic cycles. Instead, regardless of the situation of the economy or market, this strategy looks at the finest firms and stocks. In other words, instead of looking at the economy, bottom-up analysis takes a microeconomic or small-scale approach.

Due to the nature of this analysis method, a bulk of the top-down investors are macroeconomic focused, and capitalise on big trends via ETFs (exchange-traded funds) as opposed to individual equities.

They are focused more on market cycles than individual stocks, and thus tend to have higher turnover rates than bottom-up investors. Ultimately, the tactic relies on investors utilising short-term gains and leveraging on momentum to identify undervalued prospects.

#2. Top-Down

Before making a more precise investment decision, the top-down analysis examines the economic, market, and industry trends. Assume an analyst examines various industries and discovers that technologies outperform financials. As a result, individuals may elect to invest more in financials than in technologies in their portfolios.

They’ll then look for the banking sector’s best-performing companies. In contrast to a bottom-up examination, an investor may discover convincing reasons to purchase and invest a considerable amount of capital in a single technology stock. Even if the industry’s overall prognosis is bleak, the investor may feel the risk is worth it.

#3. Fundamental Analysis

Fundamental analysis assumes that a company’s shares have an intrinsic or enterprise worth that the market will eventually recognise. To determine this value, the investor needs to look at the company’s financial results.

Fundamental analysts, on the other hand, examine the situation of the company’s industry as well as the economy. To determine a company’s worth, fundamental analysts utilise variables such as earnings-per-share (EPS), dividend yield, price-earnings (P/E) ratio, and return on equity. This strategy also considers the assets, liabilities, and expenses of a business.

#4. Price-Earnings Ratio (P/E)

A price-earnings ratio depicts the relationship between the price of one share of stock and the company’s earnings-per-share over time. This time frame is usually one year. It shows how much money each investor is putting into the company for every dollar of profit it generates.

The P/E ratio is calculated by dividing the stock’s market value per share by its price per share.

Investors frequently compare the P/E of one company to the P/E of other stocks in the same industry to estimate the worth of the stocks. Lower P/E ratios are usually seen favourably by investors.

#5. Earnings Per Share

Earnings per share (EPS) is a valuable measure of profitability that, when compared to EPS of other similar companies, provides insight into the companies’ relative earning capacity.

When EPS is calculated over a period of time, it shows whether the company’s earning capacity has increased or worsened. Typically, investors seek out companies that have consistently increasing earnings per share.

Here’s a breakdown of the basic formula:

Earnings per share = (Net Profit – Preference Dividends) / Number of Equity Shares

If the capital structure (i.e. the number of shares) changes throughout the reporting period, EPS is calculated using a weighted average number of equity shares.

The metric calculates the total earnings that each stakeholder could get. However, distilling the success of an entire company into a single indicator is difficult. Because EPS is best utilized in tandem with other performance indicators, it has a limited application and should be used with caution.

#6. Book Value

The price-to-book ratio can be used by investors to find cheap high-growth companies. While a company’s book value is equal to the total number of assets minus total liabilities, the P/B is calculated by dividing the market price of its stock by the book value of equity. A low P/B ratio indicates that a company is undervalued.

The Price-to-Book formula can be measured either through (Market Capitalization / Net Book Value) or (Share Price /  Net Book Value per Share).

The Net Book Value can be measured by (Total Assets – Total Liabilities)

Typically, investors use the price-to-book ratio (also known as the market-to-book ratio) to determine the market’s opinion of a stock’s value. Apart from this, it can also be used to value insurance and financial firms, as well as real estate or investment trusts.

With that being said, businesses that own a high percentage of intangible assets might not want to use this method.

#7. Dividend Yield

The relationship between a company’s dividend payments and its stock price is known as the dividend yield. Divide the annual dividend by the current stock price to find the dividend yield. The dividend yield of one corporation can then be compared to that of another.

The dividend yield ratio is generally used by investors who want to know the exact return on an investment for a stock that has no capital gains, by measuring the cash flow received for each dollar invested in a given equity position.

If investors want to invest in firms that pay out a lot of dividends, they should look for companies with greater dividend yields.

The dividend yield ratio can be achieved with a simple formula: (Annual dividend / stock price) x 100

#8. Return on Equity (ROE)

The return on equity (ROE) essentially reflects a company’s effectiveness in converting shareholder capital into profits. The net income from a company’s income statement is combined with the shareholders’ equity from its balance sheet to calculate ROE. As a result, if a corporation liquidates its assets to pay off debt, the amount left over for shareholders is known as ROE.

Conclusion

Each of these methods can be used to achieve your desired results based on your investing preferences and unique requirements. Be sure to do your due diligence on which one works best for you, or consult someone who can establish which methods work best for your portfolio.

 

Do share with us your thoughts on these investment analysis techniques in the comments below.

 

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