Fundamental Analysis - Top Down Approach

Using a "Top Down" approach for fundamental analysis means beginning your analysis on a Global Macroeconomic level right from the start, moving to consecutive narrower economic levels until you reach the individual business itself.

This is in comparison to beginning with analyzing the individual business first, and then moving towards a global level.

When doing fundamental analysis your goal is to look at how different factors affect performance at each of the specific levels being analyzed.

This article will provide some examples of these different factors focusing on using a Top Down approach to fundamental analysis. It will also focus on looking for companies that are doing well to help identify good stocks to purchase for a long position.

For people looking for good shorting opportunities you would obviously look for areas that are, or are expected to do poorly in the future.

  • Global Economy: Beginning at the global level may turn your focus on how the majority of economies across the world are doing. Are many economies in Recession? Are they coming off a multi-month low? Has economic expansion been consistently moving higher or at least showing signs of improvement?
  • Local Economy: Looking at the local economy would be analyzing a specific country or even region. Many times due to fluctuations in currencies, employment, government stimulus and taxation issues among other things, specific countries may be doing better economically than others. Particularly when considering whether to invest in or not.
  • Sector Level: After taking at look and narrowing down to a local economy that is doing well, take a look at how specific sectors may be doing, and their outlook. An example of a sector would be the "Technology Sector".
  • Industry Level: Taking one step further, once a sector is targeted, take a look within that sector to see which industry may be doing better than others, and their outlook. An example of an industry within the "Technology Sector" would be "Application Software".
  • Specific Business Level: Once you have narrowed down a possible Industry, take a look at potential individual businesses within that industry. An example of an individual business with the "Application Software" industry would be "Microsoft".
Fundamental Analysis - Top Down Approach

Once a specific potential business is identified, then you can take a closer look at how the company is performing and expectations for future performance.

One way to do this is to look into the company financial information found on financial statements and coming up with some type of valuation.

In addition to checking financial statements and statistics you can check into any product developments in the works, new services coming or any other business plans the company has underway that may affect your decision as well as taking a look at how the management is performing and has performed compared with previous expectations.

Keep in mind that the different levels mentioned above are only examples and do not have to be included in every analysis based on each persons specific needs. For example: A business that appears to be fine individually, may be in a sector that is performing very badly with a poor local or global outlook for the future. In this case, it may not matter that the company appears to be fine. The stock price may get dragged down with others due to broader factors.

Another example would be a global and local economy that it doing poorly and has a poor outlook, but a specific sector or industry that is doing well. Maybe providing counseling services or employment services.

These are examples of using specifc levels of analysis with more weighting than others to come up with potential stocks to select.

Since this article is primarily targeting the sequence used when performing Fundamental analysis using a Top Down approach, we won't get into any specific details here about financial statistics. That will have to be addressed on another page down the road.

Here's a great resource for doing your fundamental analysis to keep you busy for a while (they have a great free as well as premium service): Unlimited Stock and Fund Insight from Morningstar. Learn More..

Note: All of the above information in this post is based on my opinions of this topic and may not be the same opinions as others have. Many times different people have different views on the same topic. When learning and doing any type of research, it's a good idea to practice and see what works for you before implementing the strategy with real funds. Better to be safe than sorry.

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