Investing is broadly categorised into two different approaches. The first involves analysing various macroeconomic factors, such as GDP, geopolitical conditions and much more before selecting the perfect stocks. The other simply focuses on analysing the performance of a company and its stocks, without emphasising on evaluating the various macroeconomic conditions.
This second type of investing is known as bottom up investing. With this approach, microeconomic factors associated with the security or business are closely studied for maximum profitability.
Understanding Bottom Up Investing
As stated previously, a bottom up approach considers the company and it’s business’ performance when deciding whether an investment is appropriate. Proponents of this procedure believe that a company can thrive even when the economy or a particular sector fails to show promise. To ensure success, an investor must still study different microeconomic factors thoroughly before picking security.
A company’s microeconomics involves its overall financial health, demand and supply statistics, financial statement analysis, services and products offered and many others.
For instance, any irregularities in the business’s accounts can indicate underlying challenges for the brand, which may otherwise look healthy. Therefore, studying these characteristics can help an investor understand whether purchasing a company’s securities is a risky prospect or not.
How Does Bottom Up Investing Function?
An investor should understand that bottom up investing does not limit analysis to just a business or company in question. This is where the emphasis is, but the research slowly progresses into areas such as the concerned business sector, market performance, economic volatility, geopolitical condition and local currency performance.
In essence, bottom up investing also analyses the same factors as that of a top-down method of investment. Nevertheless, due to its increased emphasis on microeconomic details of a company, most decisions are based on the overall performance of the business in question.
In most cases, bottom up investors practice a buy-and-hold technique, targeting long-term returns instead of short-term gains.
This is also one of the primary reasons why such an approach works. Investors who practice this analysis attain extensive knowledge about a company and its stock. This, in turn, allows them to predict the growth potential of the brand more accurately.
A bottom up approach example can clarify any doubts regarding the workings of this analysis process. Thus, consider investing in a company, such as Google. Investors are already familiar with the products and services of Google, which should ease the research process.
The initial research would include an extensive assessment of the company’s financial statement, marketing campaigns, organisation structure and price of each share. Additionally, investors would also need to determine various financial ratios for Google’s business.
After this microeconomic study is complete, an investor would proceed to research Google’s competitors. This reveals any unique service areas or products that the company offers, but others do not. Next, Google is pitted against general market conditions, and not just against the internet technology market.
All of these steps combined make up the bottom up investing process. All of the analysis can help investors decide whether Google is a profitable prospect when considering their own financial goals. Depending on the results, one can either go ahead with the trade or decide to invest elsewhere.
Benefits of Bottom Up Investing
Bottom up investments can seem too risky to some since the emphasis on analysis is limited to the company offering the security only. Nevertheless, it has some salient benefits as well –
- Firstly, such investors are exceptionally familiar with a particular business or company where they are planning to invest. This increased understanding of an enterprise’s internal working can help in the prediction of its assets and securities’ future performance.
- Some companies tend to pay significant dividends to bottom up investors, which is an attractive prospect, especially when the investor in question was planning on stock investments.
Disadvantages of Bottom Up Investing
Bottom up investing also has its share of flaws, and as such, it is not for everyone. Here are some drawbacks of utilising this analysis method –
- An investor considering bottom up investing is already biased toward a particular company and security, without considering the macroeconomic factors. This can cause complications later on or even lead to losses.
- Another drawback of this process is the immense time and effort required to research every aspect of a business. In some cases, gauging a company accurately can take months or even years.
Top-Down Vs Bottom Up Investment Methods
Refer to the table below to understand how bottom up investing is different from the top-down process.
|Factors||Bottom up investments||Top-down investments|
|Market timing||Investors remain loyal to the chosen company or stock, regardless of the financial challenges.||Since this process emphasises on an industry rather than on a particular business, individuals can enter and exit investments depending on market volatility.|
|Chance of errors||Minimal risks of making mistakes since investors have a one-dimensional focus on their preferred security.||Increased chances of missing great investment opportunities since investors are focused on a sector and not individual companies.|
|Macro trends||Minimal emphasis on macro factors.||Intense emphasis on learning the macro characteristics, such as economy, GDP and more.|
|Balanced portfolio||Increased risk of overexposure to a certain sector as all stocks belongs to one business.||Top-down investors generally possess a more diversified investment portfolio.|
Both of these methods have their ups and downs. Individuals with a perfect balance of top-down and bottom up investments should enjoy a healthy and diversified portfolio, maximising their gains.