Macroeconomic and Microeconomic Analysis in Stock Investment

You can’t go to war without a weapon. You can’t just buy a stock; you must do extensive research. You must learn to be your own stock analyst. This will help you make wise and sound investment decisions.

To do comprehensive stock research, you must apply two methods used in economics—microeconomics analysis and macroeconomic analysis.

Macro-Economic Analysis

As discussed earlier in this guide, economic forces (such as the law of supply and demand) affect stock prices. So, before you invest in a stock, you have to use a top-down global research approach. You must look at the global trends. You must look at the big picture.

As of this writing, Airbnb is not a public company yet, but for the purpose of discussion, let’s assume that it is. A lot of cities in Europe and in the United States have banned Airbnb, but it continues to grow in various cities in the world. In fact, you can find a lot of great Airbnb deals in Bali, Malaysia, Singapore, Zurich, Mykonos, and Faro. Plus, it still has a number of untapped markets. If you look at the big picture, you’ll see that Airbnb is still a great investment because of its huge growth potential.

Aside from looking at the company’s global overview, you must also consider other factors, such as:

Interest Rates

When the interest rate is high, it would be more costly for companies and individuals to pay their debts. This decreases their disposable income and their spending. This also affects business revenues and can drive down the stock prices.

But, when a country has a low-interest rate, people have more disposable income. They’ll end up buying more stuff. This could lead to an increase in stock prices.

However, you have to take note that rising interest rates can benefit specific industries, such as the financial sector — banks, mortgage companies, lending companies, and insurance companies.

The Cyclical Nature of an Industry

Before you buy a company’s stock, you have to determine if that company belongs to a cyclical industry.

Cyclical sectors such as the automobile industry and the construction industry are sensitive to the ups and downs of the economy. When the economy is good, their prices go up, but they go down when there’s a recession.

Try to avoid investing in companies in cyclical sectors (unless you’re very good at timing your investments). You’d want to invest in a stock that can withstand economic setbacks.

Stock Market Index

As previously discussed, an index tracks the performance of market leaders. So, in essence, it reflects the overall health of the stock market. If an index is trending up, it means that stock market players are a bit optimistic and a bull market may be happening.

Industry-Wide Research

Let’s say that you want to invest in luxury brands such as Louis Vuitton (LVMH) or YSL. Before you do that, you must look into the overall health of that industry.

If you look closely, you might discover that luxury brands are not doing as well as they used to be because of online shops and China-made products.

Micro-Economic Analysis

When you do macro-economic analysis, you are looking at the economy and the industry, but understand that microeconomic analysis uses a “bottom-up” approach. This means that you have to do extensive company research.

You have to look into the different aspects of the company, such as:

  • The Company’s Product — Is the product good? Does it have loyal customers? Is the product going to be relevant ten years from now? Let’s say that a music store is selling its stocks. Would you buy it? Well, let’s face it: no one buys CDs anymore. We just download music from the internet or check YouTube. Technology is changing by the minute. A widely used product may become irrelevant and unnecessary in the next few years. Just look at what happened to diskettes.
  • Sales and Revenue — Are the company earning money? Are their products doing well in the market?
  • Debt to Equity Ratio — Is the company’s debt bigger than its equity? If so, then you should run as fast as you can.
  • P/E Ratio — If the company has a high P/E ratio, it means that it has high growth potential. However, it also means that the stock is overvalued. A low P/E ratio means that the company has low growth potential, but it also means that it’s overvalued. If you’re into growth investing, choose a company with a high P/E ratio. But you have to choose a company with a low P/E ratio if you’re into value investing. Earnings per Share (EPS) — A company with high EPS is really doing well. It’s profitable. So, assuming other factors check out (e.g. it’s not using a lot of unsustainable debt to generate the earnings), it’s a good idea to invest in a company with a high EPS.
  • Company Management — Do you trust the people managing the company? Do they engage in unethical business practices? If you don’t trust the people running the company, then avoid it at all costs.

Also, make sure that the company’s profit has been trending upward at least in the last five years.

Learn The Right Investment Mindset By Reading Books

Mindset plays a large role in successful investing. My reading list contains many books on mindset.

A few weeks ago, I read the Rich Dad Poor Dad book and found it quite fascinating.

In Rich Dad Poor Dad, the author explores the steps to becoming financially independent and wealthy using autobiography and personal experience. 

Narrative writing and framework characterize this book. Not technical insights or investment math, but anecdotes with nuggets of supposed wisdom, is the focus of this book.

The author compares his biological father’s (an intelligent, but financially inept father) lessons with the lessons his friend’s father teaches him (an uneducated, but brilliant and wealthy father).

In Kiyosaki’s life, this weaves through as he learns from the rich father and rejects the advice of the poor father (thereby eclipsing typical working-class attitudes).

However, some of the concepts in this book are questionable. Learn more about my thoughts about Rich Dad Poor Dad in my Rich Dad Poor Dad review.

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