The Top-Down Approach
The top-down approach is a valuation approach that begins with first analyzing the overall economy and then continuing to drill down to the specific analysis. The idea behind the top-down approach when valuing securities is to start from a high level analysis: the general economic conditions. The next step would then be to analyze a specific industry within the economy. Lastly, an investor would compare and analyze specific securities to invest in.

The top-down approach allows an investor to make an informed investment decision based on a keen understanding of the economy and industry and how that relates the stock, versus comparing the stocks fundamentally against their peers without thinking about the overall movement in the market.

The top-down approach can be particularly useful when analyzing the valuation of world stocks. Given the starting point of understanding the world economies, an investor is able choose an appropriate stock based on areas of the world that may be doing better.

The Different Forms of Investment Returns
When considering an investment there are various forms of investment returns that could be used, depending on the type of asset being evaluated. For example, when valuing a Real Estate Investment Trust (REIT), a price to cash flow metric may be more important as a measure of return. For a stock, dividend income or earnings may be an appropriate form of return to analyze. For bonds, an investor may consider cash flow.

The important thing to keep in mind at this point is maintaining consistency with the form of investment return used. We'll discuss the various forms of investment returns in detail within the remainder of this book.

The Dividend Discount Model (DDM)

Related Articles
  1. Financial Advisor

    Are You a Bottom-Up or Top-Down Investor?

    Both of these approaches are used to pick stocks. Here's a look at how they work.
  2. Investing

    Who Benefits From Bottom-Up Investing?

    Bottom-up investing analyzes individual stocks from a specific company rather than the economy and market cycles.
  3. Trading

    Chart Summit 2017

    JC Parets discusses his top/down approach to markets, what we’re seeing in today’s environment, his approach to risk management and the arithmetic he uses for position sizing.
  4. Managing Wealth

    The Key To High Returns Is A Disciplined Strategy

    Learn about different investment strategies and how to pick the right one for you.
  5. Investing

    Understanding Bottom-Up Investing

    Bottom-up investing focuses on individual stocks. It’s the opposite of top-down investing.
  6. Investing

    Should You Use DCF for Valuation?

    We explain the two primary valuation techniques—DCF and Comparables—used to predict future stock prices.
  7. Investing

    Technical Top-Down Investing: Analyzing The Market

    The top-down investment strategy depends on economy and market strength. Find out what you should know before jumping in.
  8. Financial Advisor

    Top-Down Analysis: Finding The Right Stocks And Sectors

    The top-down investment strategy depends on economy and market strength. Find out what you should know before jumping in.
  9. Investing

    Equity Valuation: The Comparables Approach

    The premise for the comparables approach to equity valuation is that an equity’s value should bear some resemblance to other equities in a similar class.
  10. Investing

    How To Analyze Real Estate Investment Trusts

    REITs are much like dividend-paying companies, but analyzing them requires consideration of the accounting treatment of property.
Frequently Asked Questions
  1. When are Beneficiaries of a Will Notified?

    Learn when the beneficiaries of a will must be notified, and understand how this requirement varies depending on whether ...
  2. Why Does Larry Page Pay Himself a $1 Salary?

    Google co-founder Larry Page continues to take an annual salary of only $1 as chief executive officer.
  3. What is Common Stock and Preferred Stock?

    Learn about the differences between common and preferred shares. Explore situations where preferred shares have more favorable ...
  4. Can CareCredit be Used for Family Members?

    Learn more about the available options that CareCredit offers to pay for out-of-pocket medical procedures with little to ...
Trading Center