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Fundamental Analysis Investing

How To Invest using Fundamental Analysis

When studying fundamental analysis, investors can use either the top-down approach or bottom-up approach. Both approaches help investors search for the best stocks to invest in.


Top-down approach 

This approach involves looking at the big picture? in the economy and then breaking it down into details. Fundamental analysts study both international and national economic indicators, such as the GDP rate, energy prices, inflation rate, and interest rate. After considering all the economic factors and looking at the big picture,? different sectors are analyzed to identify the industry that generates the best returns. Then, investors look at individual companies within the selected industry to determine the best company in that industry, adding that company's stock to their portfolio. A disadvantage to this approach is that investors may miss good companies that are performing strong just because they are in a depressed sector.


Bottom-up approach 
This approach involves starting with specific companies rather than on the industry in which the companies operate. Unlike the top-down approach where the investor looks at the big picture, here the investor focuses his analysis on individual stocks. This approach assumes that a company can do perform well even if the industry it is in is not. Investors who use this approach simply look for companies with strong prospects, regardless of industry conditions or economic factors. A disadvantage is that investors will have different opinions on what a strong prospect is. For example, some investors may look at earnings growth while others may look at P/E ratios.


Many investors prefer the top-down approach and recommend others to examine both the economic and industry factors before deciding on which stock to purchase, which the bottom-up approach neglects to do. However, legendary investors Benjamin Graham, Warren Buffett, and Peter Lynch favor the bottom-up approach, saying that macroeconomics is a major distraction, as the projection might turn out to be incorrect. They believe that investors should concentrate their efforts on studying the quality of the individual companies.


The top-down and bottom-up approach are two distinct approaches to investing. However, some investors choose to combine the two approaches to select their stocks.