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Investment analysis is a broad term for many different methods of evaluating investments, industry sectors, and economic trends. It can include charting past returns to predict future performance, selecting the type of investment that best suits an investor's needs, or evaluating individual securities such as stocks and bonds to determine their risks, yield potential, or price movements.
Investment analysis is key to a sound portfolio management strategy.
The aim of investment analysis is to determine how an investment is likely to perform and how suitable it is for a particular investor. Key factors in investment analysis include the appropriate entry price, the expected time horizon for holding an investment, and the role the investment will play in the portfolio as a whole.
In conducting an investment analysis of a mutual fund, for example, an investor looks at how the fund performed over time compared to its benchmark and to its main competitors. Peer fund comparison includes investigating the differences in performance, expense ratios, management stability, sector weighting, investment style, and asset allocation.
In investing, one size does not fit all. Just as there are many different types of investors with unique goals, time horizons, and incomes, there are investment opportunities that match those individual parameters.
Investment analysis can also involve evaluating an overall investment strategy in terms of the thought process that went into making it, the person's needs and financial situation at the time, how the portfolio performed, and whether it's time for a correction or adjustment.
Investors who are not comfortable doing investment analysis on their own can seek advice from an investment advisor or another financial professional.
While there are countless ways to analyze securities, sectors, and markets, investment analysis can be divided into several basic approaches.
When making investment decisions, investors can use a bottom-up investment analysis approach or a top-down approach.
Bottom-up investment analysis entails analyzing individual stocks for their merits, such as their valuation, management competence, pricing power, and other unique characteristics.
Bottom-up investment analysis does not focus on economic cycles or market cycles. Instead, it aims to find the best companies and stocks regardless of the overarching trends. In essence, bottom-up investing takes a microeconomic approach to investing rather than a macroeconomic or global approach.
The global approach is a hallmark of top-down investment analysis. It starts with an analysis of the economic, market, and industry trends before zeroing in on the investments that will benefit from those trends.
Proponents of bottom-up analysis include Warren Buffett and his mentor, Benjamin Graham.
In a top-down approach, an investor might evaluate various sectors and conclude that financials will likely perform better than industrials. As a result, the investor decides the investment portfolio will be overweight financials and underweight industrials. Then it's time to find the best stocks in the financial sector.
In contrast, the bottom-up investor may have found that an industrial company made a compelling investment and allocated a significant amount of capital to it even though the outlook for the broader industry was relatively negative. The investor has concluded that the stock will outperform its industry.
Other investment analysis methods include fundamental analysis and technical analysis.
The fundamental analyst stresses the financial health of companies as well as the broader economic outlook. Practitioners of fundamental analysis seek stocks they believe the market has mispriced. That is, they are trading at a price lower than is warranted by their intrinsic value.
Often using bottom-up analysis, these investors will evaluate a company's financial soundness, future business prospects, and dividend potential to determine whether it will make a satisfactory investment. Proponents of this style include Warren Buffett and his mentor, Benjamin Graham.
The technical analyst evaluates patterns of stock prices and statistical parameters, using computer-calculated charts and graphs. Unlike fundamental analysts, who attempt to evaluate a security's intrinsic value, technical analysts focus on patterns of price movements, trading signals, and various other analytical charting tools to evaluate a security's strength or weakness.
Day traders make frequent use of technical analysis in devising their strategies and timing their buying and selling activity.
Research analysts frequently release investment analysis reports on individual securities, asset classes, and market sectors, with a recommendation to buy, sell, or hold them. Each firm offers different types of analyses, pointing to where they see trends based on their research.
For example, BlackRock, in its Weekly Commentary for Nov. 20, 2023, states that it is neutral in long-term Treasuries because it believes risks are more balanced after the last three years of rising rates. It believes the U.S. is on a weak growth path due to policy rates staying high and, therefore, does not see stocks going through significant growth. Higher rates are causing businesses to stagnate, according to BlackRock.
That being said, BlackRock is overweight in stocks as it believes the overall returns of stocks will be higher than that of fixed-income securities in the next decade.
The first step to investment analysis is identifying an investment opportunity. From there, an investor needs to determine whether this investment opportunity will create higher returns than other available investment options. Lastly, an investor will need to gauge whether the possible reward from this investment opportunity justifies the risks.
The two main types of investment analysis methods are fundamental analysis and technical analysis. Fundamental analysis involves analyzing the fundamental aspects of a company, such as its revenues, profits, cash flows, and operating expenses. It also takes into consideration the larger economy and how it might affect a company. Technical analysis looks at the patterns of stocks or other assets and uses charts and graphs to analyze the movement of prices. Technical analysis looks at past data to inform future data.
An investment analyst is an individual who analyzes financial assets and the broader economy to make investment decisions for a firm. They spend their time analyzing the financial statements of companies and the performance of the economy through government data, such as GDP, unemployment, inflation, and more. Investment analysts gather data, sort this data, analyze it, and come up with conclusions based on their research. They then recommend buying or selling assets, whether those be stocks, bonds, commodities, or other assets.
Before making any investment decision, investors need to perform an investment analysis. They need to analyze the overall economy, specific industries, economies, and global politics, to get an understanding of where they can find value and where they can avoid risks. Though there are different types of investment analysis, the goal is always to find the best place to put money for the right risk-reward ratio.
