For companies to be analyzed in detail, more than a mere calculation of intrinsic value is needed. Therefore, many professional investors use one of the following two approaches: Top-Down Investing or Bottom-Up Investing.
Each approach has its advantages and disadvantages that we will go through in this article as well as the most important features. At the end of the article, I will compare Top-Down Investing versus Bottom-Up Investing so you can see which investment method suits you best.
Top-Down Investing Focuses on Macroeconomics
Top-down investing is an investment analysis where you first focus on macroeconomic factors to make an investment decision. This approach consists of first finding industries that are doing well and then finding companies that are the best opportunities within those industries and investing in them.
These can be the performance of the macro factors of the economy, such as GDP, interest rates, employment, taxation, spending, inflation, etc, before examining micro factors such as specific sectors or further yet companies. This approach prioritizes macroeconomic, national, or market-level factors.
Bottom-Up Investing Starts From Invididual Companies
As you can guess, the bottom-up approach starts first by analyzing individual companies. This is the most important phase in which the most time is spent. To analyze individual companies you need to make a deep dive into companies’ financials, their management, organizational structure, marketing efforts, sales, price per share and other important factors. You can also calculate intrinsic value.
However, the analysis does not stop at this level. Therefore, industry group, economic sector, market and macroeconomic factors are important parts of the overall analysis, but starting from the bottom and working your way up in scale.
Top-Down Investing Versus Bottom-Up Investing
The top-down approach is suitable for investors who are more interested in indexes and do not have much time for making individual company analyses. As a result, these investors typically look to invest in overall sector-specific indices.
However, this approach can be used to filter out a number of sectors and stocks that could be profitable. For those who have the time and want to make a deep analysis of these filtered companies, they can.
On the other hand, the bottom-up approach is usually for those who invest in the long-term that rely strongly on fundamental analysis. The reason for this is that a bottom-up approach to investing gives you a deep understanding of a specific company, providing valuable insight into a company’s long-term growth potential.
Below you can find the most important features of each investing approach.
|Top-Down investing||Bottom-up investing|
|Macroeconomic factors||Microeconomic factors|
|The main focus is the performance of the national economy or broad industry||The main focus is the performance of individual stocks|
|Helps investors save time when making analyses||Helps investors find profitable growth and value stocks|
|Investors can miss some very profitable individual investments||Investors can pick stocks that are performing worse than the market average|
|Favors passive indexed strategies||Favors tactical, actively managed strategies|
|Research of a broader market and economic conditions||Research of the fundamentals of a company|
To Sum Up
Although each approach has its advantages and disadvantages, I believe that by combining both approaches we can achieve the best results.
You should first ask yourself and be realistic about how much time and will you have to devote to analyzing stocks.
If you don’t have a lot of time and will, it would be good to choose a top-down approach and invest more in stock indexes. In case you have the time and will, then a good option would be to include individual analyses of companies in areas where you are competitive.