A financial investment is any asset or instrument acquired for future profit, known as capital gains, or with the expectation that it would provide income, such as through rental or dividend yield.
Choosing the right investment can be tricky, especially for newcomers to the field. The process of evaluating an investment for income, risk and resale value is known as investment analysis, the ultimate goal being to determine whether a certain investment is a good fit for a portfolio.
Here is a summary of the more popular analysis techniques that can help you to make better investment decisions.
1. Bottom-up
With bottom-up analysis, individual equities are evaluated based on merits such as pricing power, management expertise, and valuation.
This method does not consider market or economic cycles. Instead, regardless of the situation of the economy or market, this strategy looks at stocks based on how they are performing and the reputation of the company, utilising a microeconomic or small-scale approach.
2. Top-down
Conversely, the top-down analysis examines economic, market and industry trends. It seeks to identify the big picture and all of its components, that is, using a macroeconomic approach.
3. Fundamental analysis
This is a method of evaluating the intrinsic value of an asset, and analysing the factors that could influence its price in the future. Fundamental analysis is based on external events and influences, as well as financial statements and industry trends.
4. Price-earnings (P/E) ratio
The P/E ratio depicts the relationship between a company’s share price and its earnings per share over time, usually one year. It shows how much money each investor is putting into the company for every ringgit of profit it generates.
The ratio is calculated by dividing the stock’s market value per share by its price per share.
5. Earnings per share (EPS)
EPS is a valuable measure of profitability that, when calculated over a period of time, shows whether a company’s earning capacity has increased or otherwise. Typically, investors seek out companies that have consistently increasing EPS.
It is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of the company’s profitability.
6. Price-to-book (P/B) ratio
The P/B ratio measures the market’s valuation of a company relative to its book value, that is, the carrying value on its balance sheet. It can be used by investors to find cheap high-growth companies.
The ratio is calculated by dividing the company’s stock price per share by its book value per share. A low P/B ratio indicates that a company is undervalued.
7. Dividend yield
The dividend yield, expressed as a percentage, is a financial ratio that shows how much a company pays out in dividends each year relative to its stock price.
It can be calculated with a simple formula: (Annual dividend / stock price) x 100.
8. Return on equity (ROE)
ROE essentially reflects a company’s profitability and how efficient it is in generating profits. It is calculated by dividing a company’s net income by its shareholders’ equity.
Each of these methods can be used to achieve your desired results based on your investing preferences and requirements. Be sure to do your due diligence on which approaches work best for you, or consult a finance professional.
This article first appeared in MyPF. Follow MyPF to simplify and grow your personal finances on Facebook and Instagram.