This is the analysis of a company's fundamentals from the point of view of its operations, management and financial statements within the context of the economic environment. The analyst utilizes several basic tools to conduct it.

  1. Top-down analysis
    This subset of fundamental analysis looks at macroeconomic factors such as interest rates, inflation and employment in an effort to gain a picture of the context in which the planner or analyst would be able to make investment decisions with clients. Elements of top-down analysis include the following:
    1. Business cycle - in common parlance, the waxing and waning of the economy. Knowing and understanding the current state of the economy is important, as it enables the analyst to frame the backdrop against which to evaluate the fortunes of a company or industry. Some phases of the economic cycle benefit certain businesses while others do not.
      1. Expansion - increased business activity in the form of sales, wages, industrial production, rising stock prices and property values, increased consumer demand and GDP.
      2. Peak - the crest of the expansion, from which point the economy begins to slow down.
      3. Contraction - marked by a slowdown in growth and output. Defined as two consecutive quarters of GDP contraction, a recession is a short term contraction. A more severe version is known as a depression. Increased bond defaults and bankruptcies, high consumer indebtedness, increased inventory and decreased GDP are all hallmarks of a decline.
      4. Trough - the end of a decline in business activity and the start of a turnaround.
    2. Basic Definitions
      1. Gross Domestic Product (GDP) - all of the goods and services produced within a nation, its annual economic output which includes government spending, personal consumption, private and foreign investment and exports.
      2. Inflation - a general increase in prices.
      3. Deflation - a general decline in prices.
      4. CPI - Consumer Price Index, a widely recognized measure of inflation that measures price changes on a broad array of goods and services such as housing, transportation, clothing, medical care, utilities, entertainment, etc.
    3. Economic Policy
      1. Monetary Policy - the control of the money supply by the federal reserve board.
The Federal Reserve Money Supply Controls
Promote growth and economic expansion Decrease growth and economic expansion
The Federal Reserve\'s Open Market Committee (FOMC) buys US government securities from banks, which adds to the money supply. Sell US government securities to banks which decreases the money supply as such sales are charged against a bank\'s reserve balance reducing its ability to lend, tightening credit and causing interest rates to rise.
Lower the discount rate that the Fed charges to member banks for short-term borrowing. Banks\' cost of funds decreases, increasing loan demand. Raise the discount rate that the Fed charges to member banks for short-term borrowing.
Lower reserve requirements. Banks may deposit less money with the Fed and have more money to lend. Raise reserve requirements. Banks\' deposits with the Fed increase, leaving them with less money to lend.
      1. Fiscal Policy - government budget and financing decisions arrived at through the political process. These may include:
        • government spending.
        • taxing power-tax increases tend to slow economic activity.
        • running a federal budget deficit or surplus-deficits can raise the cost of funds and crowd out private borrowing to a certain extent.

Bottom-Up Analysis

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