What’s the difference between top down and bottom up investing?

There are many different approaches an investor can take when looking at buying shares, and whilst top down and bottom up are completely different in their strategies, their desired result is exactly the same – to pick out the stocks which are guaranteed to deliver the best returns.

The top down approach focuses on the “big picture” or macro-economics. An investor who favours the top down approach would focus on economic variables such as interest rate movements or inflation. For example, say you thought there was going to be an interest rate cut in coming months, you may focus on a sector which is likely to benefit from a change to the official cash rate, like property or retail. You’d then pick out the best performing stocks in that sector and add them to your portfolio. The top down method also takes into account GDP, the yield curve and consumer expectations of a sector.

By contrast, bottom up investing is all about the detail, or the smaller picture. Investors are likely to be attracted to a particular stock through breaking news such as a takeover deal or a hot tip. They then study that company’s credentials such as its competitive position and how well its books are balanced before deciding whether or not to invest. A bottom up investor would be unlikely to be swayed by economic conditions, instead focusing on whether a particular company would offer good returns. In this sense they would study price to earnings ratio, any debt or net cash the company has and its dividend yield.

Like with all investing, it’s important to diversify. You can use whichever approach appeals to you the most, or a combination of the two. For instance you could use the top down approach to focus on a particular industry which interests you and which you believe is likely to outperform. Once you’ve decided on a sector, you can use the bottom up approach to decide which company is likely to give you the best value for your money. This is a great way to seek out a company which may not be well known, but which is performing well in its industry.

There is no right or wrong way to approach the share market and top down and bottom up strategies are neither right nor wrong, nor inferior or superior to each other. Pick whichever strategy suits you the most and make sure you do your research before deciding where to invest your hard earned money.

By Matt Comyn, General Manager, CommSec

Disclaimer: The views expressed in this article are those of Matt Comyn, a representative of Commonwealth Securities Limited (CommSec) ABN 60 067 254 399 AFSL 238814. Commonwealth Securities Limited (CommSec) ABN 60 067 254 399 AFSL 238814 is a wholly owned but non-guaranteed subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 and a Participant of the ASX Group and the Sydney Futures Exchange. As this information has been prepared without considering your objectives, financial situation or needs, you should, before acting on this information, consider its appropriateness to your circumstances and if necessary, seek appropriate professional advice.