The most common methods that investors use to analyze the benefits and risks associated with long-term investments in the stock market include fundamental analysis, technical analysis and quantitative analysis. Here's a rundown of all three.
The majority of investors who want to evaluate long-term investment decisions start with a fundamental analysis of a company, an individual stock or the market as a whole. Fundamental analysis is the process of measuring a security's intrinsic value by evaluating all aspects of a business or market. Tangible assets including land, equipment or buildings that a company owns are reviewed in combination with intangible assets such as trademarks, patents, branding or intellectual property.
When evaluating the broader scope of the stock market, investors use fundamental analysis to review economic factors, including the overall strength of the economy, and specific industry sector conditions.
Fundamental analysis results in a value assigned to the security in review that is compared to the security's current price. Investors use the comparison to determine whether a long-term investment is worth buying because it is undervalued or if it is worth selling because it is overvalued.
The process of evaluating securities through statistics is known as technical analysis. Analysts and investors use data on market activity such as historical returns, stock prices and volume of trades to chart patterns in securities movement. While fundamental analysis attempts to show the intrinsic value of a security or specific market, technical data is meant to provide insight on the future activity of securities or the market as a whole. Investors and analysts who use technical analysis feel strongly that future performance can be determined by reviewing patterns based on past performance data.
Technical analysis uses data from short periods of time to develop the patterns used to predict securities or market movement, while fundamental analysis relies on information that spans years. Because of the short duration of data collection in technical analysis, investors tend to use this method more in short-term trading. However, technical analysis can be a beneficial tool to evaluate long-term investments when combined with fundamental analysis.
Evaluation of the historical performance of a company or broad market is often done through quantitative analysis. Investors perform quantitative analysis through simple financial ratio calculations such as earnings per share (EPS) or more complex calculations such as the discounted cash flow (DCF).
The results of quantitative analysis provide insight into the valuation or historic performance of a specific security or market. But quantitative analysis is not often used as a standalone method for evaluating long-term investments. Instead, quantitative analysis is used in conjunction with fundamental and technical analysis to determine the potential advantages and risks of investment decisions.
The Bottom Line
Fundamental analysis is most often used when determining the quality of long-term investments in a wide array of securities and markets, while technical analysis is used more in the review of short-term investment decisions such as active trading of stocks. Investors use quantitative analysis to evaluate the financial stability of a company.
While some investors prefer the use of a single analysis method to evaluate long-term investments, a combination of fundamental, technical and quantitative analysis is the most beneficial.