There are many different investment strategies investors can undertake when investing in stocks. The terms “top down investing” and “bottom up investing” are strategies which are used frequently in trading. Here we discuss the meaning and differences between top-down investing and bottom-up investing.
This strategy involves analysing stocks on a macro level. This means that the investor is looking at the overall picture of the economic outlook and ascertains which sectors will be performing the best. These analysts may look at the global economy, GDP, exchange rates, inflation, interest rates, and commodity price patterns. They will assess where we are in the investment cycle and select the best performing sector in those economic conditions. An example is if interest rates are expected to drop, then the top down investor may consider investing in infrastructure stocks. As these stocks are highly geared, then lower interest rates will be beneficial to these companies. This is because their debt payments will be lower. Top-down investors have a short-term investing horizon so they are look at profiting from trades in a short period of time. They are looking at the momentum rather than value of these trades.
This investment approach involves analysing an individual company and selecting this stock regardless of what is happening on a macro level. Bottom-up investors believe individual companies can do well regardless of what is happening on a macro level. They may look to pick stocks in an underperforming sector. This type of investing is most suited for the long-term investor. Bottom up investors look at the fundamentals of the company such as debt levels, cash reserves, and earnings growth. From there they determine whether or the stock is a worth buying. These investors are looking to find undervalued companies by determining fundamental values of these stocks. Bottom up investors have a longer time horizon so it may take some time before the stock increases in value. However, they also invest in lower risk companies as the fundamentals of the companies have been carefully analysed. Their strategy tends to be one of buy and hold and less trade turnover.
Which one is better?
It all comes down to the individual investor and their risk levels and time horizon for investing. If the investor is comfortable with capitalising on the short-term momentum of a trade, then top down investing is appropriate. If the investor has a long-term investing horizon and is comfortable with holding a stock for lengthy period of time, then bottom up investing is more appropriate.
Lauren Hua is a private client adviser at Fairmont Equities.
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