What's the difference between "top-down" and "bottom-up" investing?

By Investopedia Staff AAA
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. How do I build a profitable strategy when spotting an Tri-Star pattern?

    Learn how to use corroborating evidence from technical indicators such as volume to create a profitable trade strategy based ...
  2. What is the relationship between minority interest discount and fair market value?

    Learn how to determine the fair market value and minority interest discount for the sale of a share of a closely held corporation.
  3. Are warrants more desirable than options?

    Understand what stock warrants are, the differences between warrants and options, and learn whether warrants or options are ...
  4. Why should a growth investor consider the metals and mining sector?

    Examine facts and trends about the metals and mining sector and the world economy that make metals and mining stocks attractive ...
RELATED TERMS
  1. Smart Beta

    Investment strategies that emphasize the use of alternative weighting ...
  2. Investment Crowdfunding

    Investment crowdfunding is a way to source money for a company ...
  3. Appraised Equity Capital

    The excess of the market value of an asset over its book value. ...
  4. Asset Valuation Review (AVR)

    A process that establishes an estimate of the value of a failed ...
  5. Derived Investment Value (DIV)

    A valuation methodology used to calculate the present value of ...
  6. Commercial Real Estate Loan

    definition of a commercial real estate loan

You May Also Like

Related Articles
  1. Stock Analysis

    Is SodaStream Ready For A Come Back?

  2. Stock Analysis

    Is Union Pacific Still A Good Dividend ...

  3. Trading Strategies

    Top Day Trading Instruments

  4. Trading Strategies

    Motif Investing Broker Review: Easy ...

  5. Mutual Funds & ETFs

    The Impact of the Janus Market Timing ...

Trading Center