Understanding what Bottom-Up Investing is

Bottom-up investing is an investment strategy that focuses upon the analysis of separate stocks and does not pay as much attention to macroeconomic factors and market cycles. During bottom-up investing, the trader or investor concentrates on individual businesses and their fundamentals, as opposed to focusing on the industry or sector that the business operates in or the general health of the economy as a whole. This investment approach makes the assumption that specific businesses can perform well in a sector or industry that is struggling.

By default microeconomic factors are pushed to the forefront when it comes to investing with a bottom-up approach. These microeconomic factors cover all sorts of financial aspects such as a firm’s general financial health and performance, evaluations of financial reports and statements, the services and goods on offer, the difference between supply and demand, and various other indicators of financial stability and performance over time. For instance, a firm’s marketing campaign or business structure could be a leading indicator that persuades a bottom-up investor to invest. However, accounting irregularities in a firm’s financial reports could suggest that it is facing problems in an otherwise well-performing sector.

Summary

• Bottom-up investing is an investment strategy that focuses mainly on the analysis of specific stocks and moves attention away from macroeconomic factors and market cycles.
• During bottom-up investing, the trader concentrates purely on a certain business and its fundamentals, as opposed to a top-down investing approach that focuses on industry groups or the economy as a whole.
• The bottom-up approach makes the assumption that businesses can prosper even in a sector that is struggling, on a relative basis.

How does bottom-up investing work?

The bottom-up approach can be contrasted to the top-down investing approach, which is an investing method that initially focuses on macroeconomic factors when attempting to make an important investment choice. Top-down investors instead focus on the overall health and performance of the economy, and then try to identify sectors and niches that are performing optimally. Top-down investors attempt to identify the best investing opportunities within a given industry. on the other hand, making safe decisions that are based on a bottom-up investing approach involves choosing a business and evaluating all of its fundamentals before going ahead and making any sort of investments. This includes gaining a deep understanding of the firm’s public financial reports. 

Usually, bottom-up investing does not restrict itself to the individual firm level, despite being the starting and main focal point which forms the basis of the analysis. Bottom-up investing involves starting from the specific industry sector, then the economic sector, before finally moving on to the analysis of market cycles and macroeconomic factors.

Bottom-up investors typically make use of long-term, buy-and-hold investing methods that depend heavily upon fundamental analysis. You may be wondering why this is the case. Simply put, a bottom-up strategy to investments allows investors and traders to analyze and understand the fundamentals of an individual company and its stock, offering a glimpse into an investment’s possible long-term growth and appreciation. Conversely, top-down investors are considered more opportunistic in their investing efforts, and often enter and exit trading positions abruptly in order to make earnings from temporary market movements.

Bottom-up investors reap the best results when they invest in a business that they have a deep understanding about. Firms including Google, Facebook and Microsoft are all perfect instances of this premise, as each company has global brand awareness and a consumer service or product that it used on a daily basis. When a trader analyses a business using a bottom-up approach, he or she comprehends its value from the position of how relevant it is to its customers in the real world.

Let’s have a look at an example of a bottom-up approach

Google (Nasdaq: GOOGL) is a good company for a bottom-up approach due to the fact that the investing community has a good understanding of the products and services that Google has to offer. When an investor concludes that a company such as Google is a good potential company to invest in, they usually start to analyze all aspects of the business such as management and business structure, financial reports, share prices, and marketing campaigns. This would involve working out the financial ratios for the business, evaluating how the figures have moved over time and forecast potential growth in the future.

Secondly, the investor moves away from the individual company and contrasts Google’s financial statements with those of its rivals and competitors in its industry. By doing this, analysts can identify whether or not the individual company, or in this case Google, stands out from the crowd of competitors or if it has any anomalies that its rivals do not show as having. The next stage that analysts take is to compare Google with the broader range of technology firms on a relative basis. Then general market conditions are scrutinized, for example whether Google’s P/E ratio correlates with the S&P 500, or if the stock market is in a bullish market. Last but not least, macroeconomic data is used in the decision-making process, examining patterns and trends in factors such as inflation rates, interest rates, unemployment rates, GDP growth, retail sales.  

After an investor takes all these fundamentals and macroeconomic factors into consideration, beginning from the bottom and working his or her way up, then they can decide whether it is a good investing opportunity with high profit potential.