A:

Before we look at the differences between top-down and bottom-up investing, we should make it clear that both of these approaches have the same goal - to ferret out great stocks. Now, let's look at the different strategies used by top-down vs. bottom-up investors to select companies in which to invest.

Top-down investing involves analyzing the "big picture". Investors using this approach look at the economy and try to forecast which industry will generate the best returns. These investors then look for individual companies within the chosen industry and add the stock to their portfolios. For example, suppose you believe there will be a drop in interest rates. Using the top-down approach, you might determine that the home-building industry would benefit the most from the macroeconomic changes and then limit your search to the top companies in that industry.

Conversely, a bottom-up investor overlooks broad sector and economic conditions and instead focuses on selecting a stock based on the individual attributes of a company. Advocates of the bottom-up approach simply seek strong companies with good prospects, regardless of industry or macroeconomic factors. What constitutes "good prospects", however, is a matter of opinion. Some investors look for earnings growth while others find companies with low P/E ratios attractive. A bottom-up investor will compare companies based on these fundamentals; as long as the companies are strong, the business cycle or broader industry conditions are of no concern.

(For more on the different methods of picking stocks, we encourage you to check out our Stock Picking Tutorial, A Top-Down Approach To Investing and Where Top Down Meets Bottoms Up.)

RELATED FAQS

  1. What Book Value Of Equity Per Share (BVPS) ratio indicates a buy signal?

    Find out more about book value of equity per share, what BVPS measures and how to determine what level of BVPS indicates ...
  2. Does stockholders equity accurately reflect a company's worth?

    Learn whether stockholders' equity accurately reflects a company's worth. Stockholders' equity is found by taking the difference ...
  3. How do I evaluate a debt security?

    Look at a brief overview of the important factors to consider before purchasing a debt security, such as a corporate or government ...
  4. What risks should I consider taking a short put position?

    Learn what risks to consider before taking a short put position. Shorting puts is a great strategy to earn income in certain ...
RELATED TERMS
  1. Strike Width

    The difference between the strike price of an option and the ...
  2. Systematic Manager

    A manager who adjusts a portfolio’s long and short-term positions ...
  3. Inverse Transaction

    A transaction that can cancel out a forward contract that has ...
  4. Unconstrained Investing

    An investment style that does not require a fund or portfolio ...
  5. Reference Equity

    The underlying equity that an investor is seeking price movement ...
  6. Precedent Transaction Analysis

    A valuation method in which the prices paid for similar companies ...

You May Also Like

Related Articles
  1. Investing

    is It Wise To Copy Warren Buffett's ...

  2. Investing

    5 Great Investors Who Aren't Warren ...

  3. Fundamental Analysis

    Three Benefits Of Purchasing High-Priced ...

  4. Professionals

    Is a Bond Market Selloff Coming?

  5. Professionals

    Indexing vs. Stock Picking: Which is ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!