Approaches to Security Selection
Once an appropriate allocation between different investment types (for example, stocks, bonds and real estate) has been determined, individual securities (or mutual funds) must be selected within each investment type.
There are two basic approches to individual security selection: top-down and bottom-up.
In a top-down approach the analyst examines the overall economy and market and selects sectors (for example, healthcare or financial) that are expected to perform well in the current environment. Individual companies are then selected within each sector based upon desired characteristics.
In a bottom-up approach the analyst first idenifies individual companies with desired characteristics and then examines the prospects for those companies given current economic and market conditions.
Regardless of which approach is taken it is important that the economy, market and industry conditions are considered when making the desicion to invest in individual securites of any type.
In evaluating individual securities there are also two main approaches: fundamental and technical. Fundamental analysis deals with examining a host of data such as a company’s financial statements, ratios and management in selecting securites for investment. Technical anlaysis involves looking at past trends in market price and volume information to discern the underlying trend in a security. These trends reflect underlying supply and demand and investor behavior.Often these two techniques are viewed as mutually exclusive (some people follow one but not the other). Another view is that the approaches are complimentary, a company may look great fundamentally but technical analysis may indicate it is not the best time to buy.
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
