Bottom-up Investing
Bottom-up investing is an approach to swing trading that prioritizes individual company performance over broader industry trends. In this guide, we cover how it works, advantages and drawbacks, plus strategy examples. We also look at top-down versus bottom-up investing styles.
Top Brokers For Bottom-Up Investing for United States
What is Bottom-Up Investing?
The bottom-up investing approach focuses on analyzing a company’s stock value instead of wider market performance, cycles or the overall economy. An investor will investigate a company’s revenue, earnings and outgoings, and base a stock’s investment value on their findings.
This approach makes a fundamental assumption: that a company can perform well even if the industry itself is underperforming. Essentially, it assumes that individual securities can move independently of wider market factors.
As an investor, you should consider many different microeconomic factors when assessing a company, from its overall financial health to the products and services offered, alongside supply and demand.
If a company operates with a distinctive organizational structure or utilizes an eccentric marketing strategy, a bottom-up investor may be encouraged to back them. Equally, an investor could scrutinize a company from a sector that is performing strongly, find irregularities in its financial statements, and view this as an indication of problems.
How it Works
Bottom-up investors pick an individual company and conduct a thorough review, becoming familiar with the firm’s public reports, for example. And whilst you should still look into the broader industry, your research begins at the firm level and the most weight is given to these factors. You would then bring economic, industry and other macroeconomic considerations into your analysis.
Investors tend to rely heavily on fundamental analysis and use buy-and-hold strategies over a longer period. This makes it an ideal strategy for aspiring swing traders. In contrast, top-down investors tend to prefer day trading strategies, entering and exiting positions quickly to profit from current market trends.
Bottom-up investing is generally most successful when traders invest in well-known companies that they either actively use or read a lot about. Google and Amazon, for example, are popular options.
Example
Let’s look at another popular example – Tesla:
- Delve into the firm’s financial statements, price per share, marketing efforts, future products, management and organizational structure.
- Calculate financial ratios to analyze figures over time and project future growth.
- Check out competitors. Examine the financials of other car companies specializing in electric vehicles. This can help to show whether Tesla stands out from its peers.
- Compare Tesla with the wider automotive industry – is it the front runner?
- Also consider the general market – is Tesla’s P/E ratio in line with the performance of the Nasdaq index, for example? This can help show whether Tesla is outperforming the rest of the sector or benefitting from a bullish market.
- Finally, analyze macroeconomic data like unemployment, inflation and interest rates.
Once you have weighed all these factors from the bottom up, you can decide whether you want to buy Tesla stock.
Fundamental Analysis
The approach often requires fundamental analysis of individual stocks during the idea generation stage. This can help investors pick stocks with promising future potential.
The start of the analysis process usually involves establishing the fair value of companies that could be included in a portfolio. You can then apply quantitative filters. For example, you can analyze annual financial statements, as well as look into the strength of the management team, corporate structure and operations.
Bottom-up investors also use a range of financial ratios and techniques when assessing firms. These include:
- Dividend Yield
- Price-to-Earnings ratios (P/E)
- Discounted Cash Flows (DCF)
- Return on Capital Employed (ROCE)
Bottom-Up Investing & Swing Trading
Bottom-up investing is a strategy that pairs naturally with swing trading because it focuses on long-term growth rather than short-term market spikes. Investors usually look for companies that present opportunities to buy and hold stocks that are likely to experience steady growth over weeks or months. They don’t typically look to enter and exit positions quickly just because a market is performing strongly at that particular point in time.
Top-Down vs Bottom-Up Investing
Bottom-up investing is the inverse of top-down investing. Top-down traders look at the overall performance of a sector and identify trends in business cycles, economic growth, Gross Domestic Product (GDP), and even monetary policy.
Where the bottom-up approach can value growth over value, top-down investors may choose to invest in specific regions or industries that are expected to outperform others. They assume that if a sector is doing well, stocks within that sector should perform well and bring in returns.
The right strategy for you will depend on your investment goals, risk tolerance, and the methods of analysis you prefer to use. You may also wish to use a mixture of both approaches.
Pros
There are several advantages of bottom-up investing:
- Forces traders to explore various aspects of a company with more insights into how it operates
- Identifies companies outperforming the market
- Focuses on sustainable, longer-term growth
- May help find undervalued opportunities
- Ideal for swing trading
Cons
There are also some potentials drawbacks to bottom-up investing:
- May overlook important macroeconomic factors
- Ignoring large industry trends is risky
- Research can be time-consuming
How to Start Bottom-Up Investing
Research
Identify a few companies that you are interested in, preferably those that you actively use or know well. Sift through financial statements, organizational structures, marketing strategies, price per share, future products, and anything else you can use to get a deep understanding of the company.
Remember to also leverage financial ratios and factors like Dividend Yield, Price-to-Earnings (P/E), Discounted Cash Flows (DCF), and Return on Capital Employed (ROCE). These can be used to help project future growth.
Find a Broker
Before opening a position you will need to find a broker. There are many factors to consider. Arguably, the most important consideration is that the brokerage offers exposure to the security or asset that you’re interested in. For example, if you want to invest in Tesla, ensure the broker offers Nasdaq stocks.
In addition, compare holding fees, deposit and withdrawal charges, plus commissions. Also compare the minimum deposit requirement and any available bonus schemes. Checking that the broker provides adequate customer support is also key.
Once you have opened an account, all you need to do is deposit funds and purchase the stocks you want. Make sure you also keep an eye on price charts so you can identify the right exit point.
Final Thoughts
Bottom-up investing may not be the most popular strategy, but it can be effective when implemented correctly. Importantly, the approach can be best described as a way of identifying undervalued stocks and securities with long-term potential. Follow our guide to get started today.
FAQ
What Is Fundamental Analysis?
Fundamental analysis is a method used to measure a stock’s intrinsic value. It differs from technical analysis techniques that focus on identifying price patterns and trends on charts. Fundamental analysis forms a key part of bottom-up investing.
What Is Top-Down Investing?
Top-down traders first consider macroeconomic factors and wider industry performance before focusing on specific stocks. This is in contrast to bottom-up investors that conduct a deep dive into individual company performance before considering wider market factors.
Where Does Bottom-Up Investing Start?
Bottom-up investing starts, as the name suggests, at the bottom. Traders delve deep into specific companies before analyzing industry trends and wider macroeconomic factors.
Is Bottom-Up Investing Easy?
Like all forms of trading, bottom-up investing requires hard work. It involves dedication and detailed research, but the results can be worthwhile.
Is Bottom-Up Investing Better Than Top-Down?
There is no clear winner. You should pick the right strategy for you based on your preferred researching styles and risk tolerance.