Investment Theory and Portfolio Development - Fundamental Analysis

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
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: Vanguard Total World Stock

    Learn about the Vanguard Total World Stock exchange-traded fund, which invests in stocks located in numerous countries with a high level of diversification.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares US Real Estate

    Learn about the iShares US Real Estate fund, which holds shares of equity and nonequity real estate investment trusts incorporated in the United States.
  4. Mutual Funds & ETFs

    ETF Analysis: SPDR Barclays Short Term Corp Bd

    Learn about the SPDR Barclays Short-Term Corporate Bond ETF, and explore detailed analysis of the exchange-traded fund tracking U.S. short-term corporate bonds.
  5. Investing Basics

    What to Cut From Your Portfolio Right Now

    Owning stocks may shortly become too scary for your portfolio. Here's why, and here are some alternatives.
  6. Forex Strategies

    How To Avoid Exchange Rate Risk

    What are the best strategies to avoid exchange rate risk when trading?
  7. Investing Basics

    How AQR Places Bets Against Beta

    Learn how the bet against beta strategy is used by a large hedge fund to profit from a pricing anomaly in the stock market caused by high stock prices.
  8. Investing

    6 Reasons Why Every Investor Should Consider ETFs

    Once you understand the benefits of ETFs, you’ll see how they could be an exciting and smart way to help meet your financial goals. Here some key facts.
  9. Investing News

    Oil or Gold: Which Will Recover First?

    Not sure where oil and gold are headed? The answer is complex.
  10. Professionals

    Boomers’ 401(k)s are Way Out of Whack: What to Do?

    Many baby boomers have been investing heavily in equities in their 401(k)s. Now may be the time to rebalance to avoid huge losses if the market tanks.
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  3. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  6. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  4. How does being overweight in a particular sector increase risk to a portfolio?

    An investor who is overweight in a particular sector risks a loss in value for the portfolio if there is a downturn in that ... Read Full Answer >>
  5. What are the primary risks an investor should consider when investing in the retail ...

    The retail sector consists of companies operating in multiple industries such as specialty retail, general retail, food and ... Read Full Answer >>
  6. What risks do I face when investing in the insurance sector?

    Like all equity investments, insurance companies present investors with market risk. Insurance companies, like banks, also ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!