Process of Investment Research
Investment research involves fundamental analysis, technical analysis, or a combination of the two. Fundamental analysis essentially explains what to buy while technical analysis could be used to decide on when to buy.
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Fundamental Analysis
Fundamental analysis begins with the assertion that the ’true’ or ’intrinsic’ value of any financial asset equals the present value of all cash flows that the owner of the asset expects to receive. Accordingly the fundamental stock analyst attempts to forecast the timing and size of these cash flows and then converts them into equivalent present value by using an appropriate discount rate . Once the true value of the asset is determined, it is compared with the current market price of the asset in order to see whether the asset is fairly priced. Those assets whose price is above the intrinsic value are said to be ’over valued’ and those whose prices are lower than the intrinsic value are ’under valued’. The magnitude of the difference between the current market value and ’true value’ is also important information, because the strength of the research conviction that whether a given asset is incorrectly priced will partly depend on this information. To determine the intrinsic value, the financial statements of a company are extensively analyzed. Other factors such as its credit rating, business model, competitor parity of the company are also thoroughly scrutinized.
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Technical Analysis
Technical analysis involves the study of stock market prices of the financial asset under consideration, in an attempt to predict the future price movements it may take. Initially, past prices are examined in order to identify recurring trends or patterns in price movements. Then more recent prices are analyzed in order to identify emerging trends or patterns that are similar to past ones. This analysis is done in the belief that these trends or patterns repeat themselves. Thus by identifying an emerging trend or pattern, the analyst hopes to accurately predict future price movements for that particular asset.
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Combination Technique
As can be seen, neither of the two methods is comprehensive. A synthesis of the two would be ideal rather than any one, giving the investor information on what to buy and when to buy it.
Apart from these two broad based techniques there are other techniques like passive investing which involves investing in index stocks or funds based on an active index.
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