Frens,
Carrying on from where we left we will discuss in brief about 1. Top Down and 2. Bottom Up approach to picking stocks using Fundamental Analysis.
Top Down approach:
In top down approach, an investor tries to identify those economies (countries) of the world, which are expected to grow at a faster pace than other counties. Within these economies, the investor tries to identify the industries, which are expected to witness higher growth than other industries. After that the investor tries to find out the companies in these high growth industries. Investor now buys stocks of these companies. The investor expects to benefit from the higher earnings, which these companies are expected to create over next many years. In essence, here the investor will have a portfolio of stocks from faster growing economies (countries)
Bottom Up approach:
Bottom up approach involves finding companies, which are expected to grow their business without restricting the stock-picking search to any particular country or industry. Its Open mind no holds barred! All the stocks listed in all the stock exchanges in the world, irrespective of country or industry of operation, are open for selection to the investor. The investor uses various selection criteria to search for the best stocks even if its in an economy or country which doesn't have a growth outlook. All she cares here is she wants to invest in a great company and the belief is that great companies will be profitable immaterial of economic cycles or industry sector. Any industry is fine here; doesnt need to be a high growth industry. You may find a awesome company ina not so high growing industry. Once the investor finds a good company basis his definition, he buys its stock and expects to benefit from the future growth of the business of the company.
Comparison between Top Down and Bottom Up approaches:
Top down approach limits an investor’s analysis to stocks of only a few countries and a few industries. It also needs you to be tracking economies and industry outlook very closely. However, bottom up approach does not have this limitation. Bottom up approach provides an investor the option of investing in those companies, which are doing very good but they could also be in an industry sector, which is currently not doing well even though the overall economy of that country may be doing well. Such companies are known to make huge wealth for investors when the tide turns around. Here you may chance upon boaring companies with boaring names, but as per Peter Lynch these are the hidden gems! Who knew PAGE industries which sells undergarments would be such a big firm now...was then boaring now interesting, everyone wants to own PAGE Industries share if not wear a JOCKEY!. Too late the train has left!
Hence my viewpoint is that bottom up approach gives the investor more options to choose his stocks and is fairly easier than top down where in you need to be adept at assessing the economy and industry sector etc. The only criteria here is to find a great company, without worrying too much of the industry in which it operates or if the economic cycle of the country in which it operates is favourable or not.
In the next post we will look at the 4 pillars of Fundamental Analysis I follow, by detailing each pillar.
Untill then, have a nice time!
