Some Key Elements of a Financial Analysis

After a brief introduction to the theory of investment, we will study the major economic concepts that govern the financial markets.

This part aims to give you the economic rudiments necessary to understand the information you hear or read in newspapers about the world situation. Why does the US Federal Reserve raise its interest rates? What is the impact of inflation on stock prices? Etc. Many notions that must be known to best address the study of financial markets.

Complex parameters

We can analyze the course of action according to factors whose classification is concentric, first of all, there are the proper qualities of the society which constitutes the first circle, the nearest. Then this company is part of a specific business sector that influences its behavior. And finally, all these data evolve according to national and international economic parameters.

The complexity of the analysis comes from the fact that these factors are all interdependent and that the modification of one of them has repercussions on the whole chain.

The following paragraphs, therefore, provide you with a synthetic vision of the basic economic concepts you need to know in order to approach stock market investment more calmly.

Economic cycles

The economic activity is characterized by an alternation of more or less long phases of expansion and recession; the economic growth of a country is not linear. These economic fluctuations constitute economic cycles.

These changes in economic activity are measured by indicators, the most widely used in France is the Gross Domestic Product (GDP).

The impact of business cycles on the stock market is particularly important. In the growth phase, companies’ order books are full, their turnover and their results are increasing and consequently their market valuation too.

The essential for the investor is to detect the phase of the cycle in which one finds oneself and to anticipate the reversals of cycles. This task is far from easy and its implementation is complicated by the fact that the stock market anticipates all the information.

The theoretically ideal time to invest is located at the end of the recession phase before recovery is noted. It is at this point that investors who are aware of the medium-term return to an expansion phase will begin to anticipate this future growth. Stock prices will recover before the recovery is visible.

Inflation and deflation

Inflation is defined as a phenomenon of the permanent and generalized rise in the average level of prices. In France, the inflation measurement tool is the INSEE price index, which measures, on a monthly basis, the average evolution of consumer prices.

Each country has its own index, which should be followed regularly. The price index most followed by analysts is certainly that of the United States, any increase in this index being a sign of inflation, it leads to a fear of tightening the monetary policy of the states (increase in interest rates ), which is negative for stock prices.

In times of inflation, the currency loses its value, consumers see their purchasing power decrease if their incomes do not change or if their income increases less quickly than prices.

The typical behavior in case of high inflation is a flight from the currency. Indeed, as money is losing value every day, consumers are redirecting their cash flows towards assets that are resistant to erosion.

Securities are part of this asset class. Generally, the invoices of companies follow the inflation which has the effect of increasing their turnover and pulling their stock prices upwards.

Inflation is therefore beneficial to the stock market valuation of companies, but we must not lose sight of the fact that the real increase will not be the increase in prices in absolute value but the evolution gap between share prices and the share price. ‘Inflation. If prices rise over a 10% year with 5% inflation, the real increase is only 5%.

The phenomenon of deflation, which is the opposite of inflation, results in a general fall in prices. Its impact on the valuation of the stock market is therefore negative.

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