You may have heard the term from money managers on BNN’s Market Call; “I’m top-down” or “I’m bottom-up”.
They are referring to vastly different approaches to investing, and while many investment advisors do both, some mutual funds specifically employ one or the other (which is why it’s important to read the prospectus).
To understand top-down versus bottom-up investing, imagine one investor getting in a helicopter to survey the ground for the best opportunities, and another grabbing a shovel and digging for hidden treasure.
Approaches often vary but here is a typical checklist for the top-down investor:
Does the economy present a good investment climate?
Are equity markets priced right?
Is there growth potential for the sector?
Is the company poised to out-earn its peers based on revenue growth and management?
Bottom-up investor, also known as value investors, will typically begin their search with the final consideration for top-down investors: is the share price of the company trading below its real value based on fundamentals such as earnings?
Regardless, all stocks are influenced by the broader market, so from there they will look to see if the investing climate is right.
Many bottom-up investors say they don’t take sectors or the economy into account but some will quietly test their thesis from the top down just to be sure.