What is meant by bottom-up investing? Should you go for it?

Summary

  • Bottom-up investing focuses on the microeconomic factors such as analysis of individual stocks.
  • Bottom-up investors assume that individual companies can excel even if the industry underperforms.
  • This investing approach also requires significant time and effort to research every aspect of a business.

Investing is generally divided into two broad approaches. While the first one considers various macroeconomic factors such as the gross domestic product, and geopolitical situation, the second one analyses the performance of a company or its shares without focusing on macroeconomic conditions. The second type of investing approach is referred to as bottom-up investing.

                   

What is meant by bottom up investing Should you go for it?

 

Bottom-up investing focuses on the microeconomic factors such as analysis of individual stocks and ignores the significance of macroeconomic cycles and stock market cycles.

Investors with bottom-up investing approach assume that individual companies can perform well even in an industry with weak performance or in times of sluggish overall economy. Thus, they find it more important to focus on a particular company and its fundamentals.

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How does bottom-up investing work? 

Before picking up stocks, bottom-up investors study a company’s overall financial health, financial statement analysis, demand, and supply statistics, among others. Based on these microeconomic factors, investors decide whether buying securities of the company is a risky affair or not.

As the name suggests, investors start from the bottom and work their way up in scale towards industry group, economic sector, market, and macroeconomic factors for overall analysis.

Bottom-up investors generally have long-term buy-and-hold strategies. Such an approach provides investors with a deep understanding of a company and its stock. It also provides an insight into an investment's long-term growth potential.

Advantages of bottom-up investing 

  • Since bottom-up investors are highly familiar with the company’s fundamentals and its internal working, they are in a better position to predict the future performance of its securities.
  • There are companies that tend to pay dividends to bottom-up investors. 

Disadvantages of bottom-up investing 

  • Since bottom-up investing does not consider macroeconomic factors and only focuses on a particular company or security, investors may face challenges later.
  • This investing approach also requires significant time and effort to research every aspect of a business.

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Differences between bottom-up and top-down investing 

  • While bottom-up investing focuses on microeconomic factors impacting a company, the top-down approach examines different macroeconomic factors to see how these factors may affect the overall market.
  • There is an increased risk of overexposure to stocks of one sector for bottom-up investors. On the other hand, top-down investors generally have a more diversified investment portfolio.
  • Bottom-up investors have less risk of committing mistakes since their focus is one-dimensional. Top-down investors face a possibility of missing good companies since these are more focused on the sector than companies.
  • Bottom-up investors are usually more loyal towards their stocks compared to top-down investors who may enter or exit investments depending on the stock market volatility.

While both investment approaches involve certain benefits and risks, investors should try to balance both to maximise their returns. However, proper advice is needed before adopting any of the investment approaches.

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