Explaining Bottom-Up Approach to Investing
Bottom-up investing refers to an approach that concentrates on the analysis of an individual stocks and doesn’t emphasize the importance of macroeconomic cycles and market phases.
With this kind of investing, you focus on a specific company and its fundamentals instead of on the industry in which the company operates or on the broader economy.
This strategy believes that individual companies can do better even in an industry that is not performing well.
This approach to investing requires the investor to focus on the microeconomic factors, which are of highest priority in this strategy.
These factors include the company financial health, financial statements, products, services, supply, demand, and other indicators of corporate performance over a period of time.
For instance, a firm’s unique marketing strategy and organizational structure may be a leading indicator that compels a bottom-up investor to invest.
Conversely, a bottom-up investor may not invest in a company because of accounting discrepancies on its financial statements. That’s because it may mean problems for the company.
Bottom-Up Investing for Investors
The bottom-up approach is the polar opposite of the top-down approach, which is a technique that first considers the macroeconomic factors when making an investment decision.
Top-down investors look at the broader performance of the whole economy and then find industries performing solidly. They then invest in the best opportunities in that industry.
On the flipside, bottom-up investors make sound decisions by picking a company and reviewing it thoroughly before they commit.
That means they should be familiar with the company’s public research reports.
On most cases, bottom-up investors go beyond the individual firm, even though that is where analysis begins and where the heaviest focus is given.
The industry group, economic sector, market, and macroeconomic factors are also given attention eventually, but analysis starts from the bottom, working the way up.
Bottom-up investors are typically those who use long-term, buy-and-hold strategies that depend on strong fundamental analysis.
This is because a bottom-up strategy gives an investor a deep understanding of a single company and its stock, offering insight into an investment’s growth potential for the longer-term.
On the flipside, top-down investors can be looking for more opportunities in their investment strategy. They may enter and exit positions in a rapid manner to make profits from the short-term market movements.
Bottom-up investors can succeed largely when they invest in a company that they actively use and know about from the ground.
When an investor looks at the company from the bottom-up, the investor first understands the company’s value from the point of view of relevance to consumers in the real world.
Bottom-up investors will seek to find out the fundamentals of a company to know whether or not to invest in it.
On the flipside, top-down investors consider the broader market and economic conditions when they are choosing stocks for their portfolio. They typically analyze gross domestic product (GDP), interest rate movements (as decided by the central bank), inflation, and commodity prices to see where the stock market may be going forward.