What Is Investment Analysis?

Investment analysis is a broad term encompassing many different aspects of evaluating financial assets, sectors, and trends. It can include analyzing past returns to predict future performance, selecting the type of investment instrument that best suits an investor's needs, or evaluating securities such as stocks and bonds, or a category of securities, for risk, yield potential or price movements.

Investment analysis is key to any sound portfolio management strategy.

How Investment Analysis Works

Investment analysis can help determine how an investment is likely to perform and how suitable it is for a given investor. Key factors in investment analysis include entry price, expected time horizon for holding an investment, and the role the investment will play in the portfolio.

In conducting an investment analysis of a mutual fund, for example, an investor looks at factors such as how the fund performed compared to its benchmark or peers. 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 always fit all. Just as there are many different types of investors with varying goals, time horizons, and incomes, there are also securities that match best within those individual perimeters. An older investor may be more risk-averse than a young one who is just beginning to save for retirement.

Investment analysis can also involve evaluating an overall investment strategy, in terms of the thought process that went into making it, needs and financial situation at the time, how decisions affected a portfolio's performance and the need for correction or adjustment if any.

Investors who are not comfortable doing their investment analysis can seek advice from an investment advisor or another financial professional.

Key Takeaways

  • Investment analysis involves researching and evaluating securities to determine their future performance and their suitability, given an investor's needs, goals and risk tolerance.
  • Investment analysis can also involve evaluating an overall financial or portfolio strategy.
  • Types of investment analysis include bottom-up, top-down, fundamental, and technical.

Types of Investment Analysis

While there are countless individual ways to analyze securities, sectors, and the markets, investment analysis can be divided into a few different categories.

Top-Down vs. Bottom-Up

When making investment decisions, investors can use a bottom-up investment analysis approach or top-down approach. Bottom-up investment analysis entails analyzing individual stocks for their merits, such as valuation, management competence, pricing power, and other unique characteristics of the stock and underlying company. Bottom-up investment analysis does not focus on economic cycles or market cycles firsthand for capital allocation decisions. Instead, it aims to find the best companies and stocks regardless of the overarching economic, market, or particular industry macro trends. In essence, bottom-up investing takes more of a microeconomic—small scale economic—approach to investing rather than a large scale, national economy or global—macroeconomic—approach.

The macroeconomic approach is a hallmark of top-down investment analysis. It emphasizes economic, market, and industry trends before making a more granular investment decision to allocate capital to specific companies. An example of a top-down approach is an investor evaluating different company sectors and finding that financials will likely perform better than industrials. As a result, the investor decides the investment portfolio will be overweight financials and underweight industrials. They then proceed to find the best stocks in the financial sector. On the contrary, a bottom-up investor may have found that an industrial company made for a compelling investment and allocated a significant amount of capital to it even though the outlook for its broader industry was negative.

Fundamental vs. Technical Analysis

Other investment analysis methods include fundamental analysis and technical analysis. The fundamental analysis stresses evaluating the financial health of companies as well as economic outlooks. Practitioners of fundamental analysis seek stocks they believe the market has mispriced—trading at a price lower than that warranted by their companies' intrinsic value. Often encompassing bottom-up analysis, these investors will evaluate a company's financial soundness, future business prospects, dividend potential, and economic moat to determine whether they will make satisfactory investments. Proponents of this style include Warren Buffett and his mentor, Benjamin Graham

The technical analysis stresses evaluating patterns of stock prices and statistical parameters, via 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 positions' entrances and exits.

Real-World Example of Investment Analysis

Research analysts constantly release investment analysis reports on individual securities, asset classes, and market sectors, evaluating the outlook and recommending a buy, sell, or hold the position on the sector. For example, on March 28, 2019, Charles Schwab issued an analysis of consumer staples equities. The report takes a macroeconomic approach, looking at various positive and negative political and economic developments that could influence the sector. They looked at retailer cost-cutting efforts, the increase in merger and acquisitions (M&A), trade disputes, and geopolitical anxieties. The analyst's then assigned an overall neutral assessment rating of "market perform." This neutral rating basically means the subject of the analysis should provide returns in line with that of the S&P 500.