What is bottom-up investing?
Bottom-up investing is an investment strategy that focuses on analyzing individual stocks and disregards macroeconomic and market cycles. Bottom-up investing focuses on a specific company and its fundamentals, rather than the company’s industry or the economy as a whole. This approach to investing assumes that individual companies can still do well even if their industry is not doing well.
In bottom-up investing, the investor should focus primarily on microeconomic factors . These can include factors such as:
- The financial health of a company
- Analysis of annual accounts
- The products that are sold
- Supply and demand.
A company in a bad industry may still be worth investing in if they can provide a unique customer experience, while a company in a successful industry may not be worth the risk because they have not demonstrated innovation over the years.
How does bottom-up investing work?
A bottom-up strategy is the opposite of a top-down strategy. With a top-down strategy, macroeconomic factors are first examined . For example, investors with this strategy first look at the general state of the economy, then look for a successful sector and invest in the best options in that sector. While with a bottom-up strategy, the investor chooses a company to invest in and researches that company thoroughly before investing. For example, you can think of looking at the public research reports of the company. With bottom-up investing, macroeconomic factors can also be examined, but the analysis always starts as small as possible (with the company itself) and is only later expanded to, for example, the entire sector.
Bottom-up investing is most often used by investors who employ long-term, buy and hold strategies that are backed by fundamental analysis . This is not surprising as a bottom-up approach gives investors a good look at a specific company and its stock; this gives the investor a good insight into the stock’s long-term potential. Top-down investors on the other hand can take advantage of short-term market changes; by quickly buying and selling stocks they can make a profit by taking advantage of these changes.
Bottom-up investors are usually most successful when they are also personally invested in the company. Take a company like Google, as an investor is likely to personally use the company’s products. This will give the investor a good idea of the true value of a company to its customers.
Example of a bottom-up approach
If an investor decides that Google, for example, is a good company to invest in, they will begin extensive research. The investor will look at things like the company’s organizational structure, financial statements, marketing efforts, and price per share. This will also involve things like calculating the company’s financial ratios and analyzing how these numbers have changed over the years in order to predict future growth.
After this analysis, the analyst will look at the bigger picture. Starting with Google’s competition and how the company is doing compared to this competition. Does Google differentiate itself from its competition? Are there any problems that are unique to Google? After this, Google is compared in general to other technology companies. The analyst looks at the general market, such as whether Google’s P/E ratio is on par with the S&P 500 and how the stock market is doing in general. In the final step, macroeconomic factors are looked at, such as inflation and GDP growth. Once this analysis is complete, a decision can be made whether or not to invest in Google.
Bottom-up vs Top-down
Bottom-up investing is a strategy where the individual company is first looked at before more macro factors are added to the analysis. Top-down investing, on the other hand, looks first at macroeconomic factors and how they will influence the market.
Top-down analysts look at GDP, interest rates, inflation and the price of goods to see how that will play out in the market. They also look at how the entire sector is doing. They believe that if the sector is successful, that is probably good news for their stocks. That is why they also look at how things like the price of oil or the price of goods change and what effect that will have on which sectors. In this way they also think they can see what effect that will have on the companies in these sectors.
For example, if the investor is interested in a company that uses chicken for their products, but there is an outbreak of bird flu, the investors will first look at how that outbreak will affect the price of chicken. And as a result, the profits of the company they are interested in. So their analysis starts very generally, looking at the big picture, the macro economy. Then they look at the sector and only then at the stocks themselves. Top-down investors can also choose to invest in a specific country or region only , if that economy is doing well. For example, it is a good idea not to invest in American stocks if there is unrest in the country. While it might be a good idea to invest in Chinese stocks when that economy is growing strongly.
Conclusion: the difference
In short, you can say that bottom-up investors will examine the fundamental principles of a company. Based on this, a decision is made whether or not to invest. While top-down investors base their decision on how the market in general and the economy itself are doing.
Start investing
Do you want to start investing yourself and buy shares for example? Then you need an account with a broker. Compare all brokers now !
Our reading tips
for the novice investor
