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Definition: Top Down Analysis
Top-Down Analysis is an approach used by investors to pick stocks is the where an investor looks into the macro-economic factors, developments in the economy and then narrow down to individual stocks. It consists of analysing the global markets, looking at market trends, studying the targeted economy and identifying the sector for investment. It is imperative for an investor to pick the right stocks to create value.
The approach of top down analysis can be described in the following steps:
a. Analyse the Global Markets: this is the first step, it is of utmost importance to analyse the global market conditions. This can be done by looking at the Gross Domestic Figures of the emerging economies as well as the developed economies. The GDP figures should be taken for a considerable timeline to understand the past trends and predict the future trends.
Investors should stand clear from investing in countries that are facing geopolitical tensions or are at war. For example it would not be wise to invest in Syria, Iraq, and Jerusalem at the moment due to high civil unrest in these economies.
b. Look at the Market Trends: the next step is to evaluate and analyse the trends in the stock market indexes of the targeted countries. This is done to figure out whether the markets there are trending up or down. Since investors invest others money this is a very critical analysis.
c. Study the targeted economy: After figuring out where to invest, investors should do an in-depth study of the country’s economy where they want to invest money. They should do a comparison of it with a major economy like the USA and look at inflation, employment and interest rates to understand the macro economic factors. Investors can then narrow down to various ratios like Price-Earning, Dividend Yield etc. of the market index. Investors can also buy government or corporate bonds after looking at their ratings given by major credit evaluation agencies.
d. Identify the Sector to Invest: After evaluating the ratios of the index, investors look at various sectors to invest money. Investors should look at the future trends and customer behaviour to narrow down on the sector they want to invest. For example: In India, automobile sector, start-up industry, alternate energy would boom in the near future, hence this would be the right time to lock in in these sectors. While picking up a sector an investor should not only look at the current market scenarios, an investor should also take into consideration the future prospects of that sector and figure out if the investment would be profitable over a long term. Sector picking is also an important task as it varies from country to country. After all this is done, individual companies should be identified, there financials should be read in detail and then correct investments should be made.