Investment Analysis Definition

Investment analysis is a broad term that encompasses 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.

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 has performed compared to its benchmark. The investor can also compare the fund's performance, expense ratio, management stability, sector weighting, style and asset allocation to similar funds. Investment goals should always be considered when analyzing an investment; one size does not always fit all, and highest returns regardless of risk are not always the goal.

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 own investment analysis can seek advice from an investment advisor or another financial professional.

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 company. Bottom-up investment analysis does not focus on economic cycles or market cycles firsthand for capital allocation decisions but instead aims to find the best companies and stocks regardless of economic, market or particular industry macro trends. In essence, bottom-up investing takes more of a microeconomic approach to investing rather than a macroeconomic one.

The macroeconomic approach is a hallmark of top-down investment analysis. It emphasizes economic, market and industrial 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 his investment portfolio will be overweight financials and underweight industrials. The investor then proceeds to find the best stocks in each 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. 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—that is, 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. 

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.

Research analysts constantly release investment analysis reports on individual securities, asset classes, and market sectors, evaluating the outlook and recommending buy, sell, or hold positions. 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: retailer cost-cutting, increase in merger and acquisitions, trade disputes, geopolitical anxieties. The analyst's overall rating was "market perform," a neutral assessment that basically means the subject of the analysis should provide returns in line with that of the S&P 500.