Just like how you want to choose good quality Pokemons with high individual values (IV) in your Pokemon Go game, you would also want to choose good quality stocks to add into your portfolio. However, the question is - how do you determine whether the quality of a stock is good or bad?
Fundamental Analysis is one way to analyse whether a stock is worth to be invested in. In general, fundamental analysis involves analysing the economy, industry or company, derive an intrinsic or fair value, and compares it to the current share price of a particular stock.
Top-Down Investing and Bottom-Up Investing
For top-down investing, you start by analysing the macroeconomic factors to identify potential companies to invest in. When using this approach, you have to question and identify, sequentially, about which country/economy, industry and company is doing well or has potential to do well in the future.
The opposite is true for bottom-up investing. It starts by analysing the microeconomic factors to identify potential companies to invest in. When using this approach, you have to question and identify, sequentially, about which company, industry and country/economy is doing well or has potential to do well in the future.
Qualitative and Quantitative factors
Macroeconomic and microeconomic factors can be categorised into two categories, namely qualitative and quantitative factors. Qualitative factors are things such as the business model or management team which are difficult or impossible to give a definite measure. For example, it is difficult to judge the management team’s integrity or competence and attach a definite measure to it.
On the other hand, quantitative factors are things such as costs or revenues which can be measured in numeric terms. These factors can be found in various reports or financial statements which give investors a definite way to compare and measure the quality and performance of an economy, industry or company.
Find out how to read financial statements here: How to Read Financial Statement
Intrinsic value or fair value is the perception of a company’s actual value after taking into account of all aspects of its business. After analysing and identifying the potential companies to invest in, investors have to use valuation methodologies to estimate the fair value of the stock to check whether it is currently cheap or expensive to purchase that stock.
Some valuation methodologies include using Financial Ratios, Dividend Discount Model and Discounted Cash Flow analysis. To learn in detail about using valuation methodologies to evaluate stocks, here are some courses offered by SGX Academy which will help you with your investment journey:
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