In the financial market, technical and fundamental analysis are the primary methods of stock evaluation. They help investors and traders understand the potential of a stock and also predict future price movements. Of these, technical analysis is mainly focused on the prediction of the performance of a stock by taking into consideration the price trends. On the other hand, fundamental analysis is primarily concerned with analysing internal factors like the growth prospects of the company, its financial potential, competitive edge compared to others in the sector, and quality of management.

A major tenet of fundamental company analysis is concerned with gaining insights about the broad sector and the specific firm. This analysis is called the business and industry analysis. In this article, we explain the primary approaches to business and industry analysis and how investors can understand the impact.

• Investors can choose between analysing the economy and industry first (top-down) or starting with strong companies (bottom-up) to guide investments.
• Some metrics for analysis include year-over-year sales growth, performance against competitors, and efficient profit generation.
• Companies balance reinvesting profits and rewarding shareholders, influencing long-term growth and value creation.

Business and industry analysis is an important consideration for investors and traders who want to be confident in their investments. These are the top-down and the bottom-up approaches. There are no rights or wrongs here and you should pick an approach according to your preferences and goals.

Top-down approach

In this approach, you typically first analyse the broader economy, then the industry that the business falls under, and finally the given company. You start from the broadest perspective and gradually zero down. This methodology enables investors to consistently narrow down from a broader range of shares as they understand the economy and the state of the industry in which the company operates. This would help you understand which industries are strong performers before moving on to the company-specific analysis to shortlist for your portfolio.

Bottom-up approach

This is the exact opposite of the top-down approach. In this method, investors start by choosing businesses that they believe will grow in time. These choices are made without restricting the scope of the search. The stocks you choose are not restricted by industry or any other factor. First, you choose companies with strong business models, then analyse their sectors, and then the support of the broader economy.

Along with the approaches to business and industry analysis, you must also know some major techniques and tools to understand the impact of this analysis. Here are the major metrics:

Year-on-year sales growth

This metric is a crucial part of a company’s historical financial performance data. Scoring well here means that a business has a distinct advantage in its sector. Still, it is key to note that increasing year-on-year sales growth is not the only factor to consider when you want to understand the quality of a stock.

Performance comparison with peers

To understand the strength of a stock, it is also crucial to compare its performance with its competitors in the same industry. For instance, even though a company may be gradually getting better, if the overall sector is consistently outperforming it, its growth may actually be slower than originally thought.

Conversion of sales growth into profit

Fundamental analysis of a company also includes assessing how efficiently it is converting its sales growth into profits. For instance, a company’s growth could always be fuelled by increased expenses. In this case, increased sales growth will not effectively translate to profits.

Profit retained and shareholder value-creation

Every company that turns a profit faces several choices. One such crucial choice is whether to reinvest the profits for future growth and expansion or pay out shareholders. Typically, companies that are comfortable in their industry and have a solid business edge provide more value to their shareholders.

Business and industry analysis is essential for informed investing. By using top-down or bottom-up approaches, investors can identify strong sectors and companies. Moreover, key metrics like sales growth, peer performance, and profit conversion help assess a company's growth potential and value creation, guiding confident investment decisions.