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What is Top-down and bottom-up investing approach?
Top-down investment approach: It is a more broader approach wherein the investor arrives at few select stocks accounting the bigger picture that covers economic outlook in a given nation. Besides this the investor or fund manager determines which industry or sector will outperform others.
And depending on the forecast of good performance by a particular sector, the investor then shortlists a company from the sector to invest in and includes it in one's portfolio.
For instance, if the fund manager or investor sees an optimistic economic outlook, one may decide to buy stocks across the board or selectively stock of a particular sector that is likely to show an exemplary performance in contrast of others such as in a scenario when the interest rates are heading southwards a fund manager may shortlist stocks of the real estate sector that is anticipated to show good performance.
In the other case, when the manager or investor foresees, weak economic outlook, he may decide on selling his stakes in some of the companies and can instead decide on betting on defensive stocks, including pharma and consumer durable stocks.
Bottom-up approach of investing: It ignores the broader aspect of the economy as well as the sector of which the company is a part and instead the focus for deciding on a good stock to invest in shifts entirely to the several aspects of that particular company. So, in all company's overall strength becomes the deciding factor.
And so different performance metrics are used by different industries for determining stocks with huge potential. Some investors and fund managers make use of earning potential; some compute P/E ratio or price to earnings multiple and stock with the lowest P/E is considered attractive for investment. So, in all fundamentals of the company form the basis for determines stocks with good earning potential. Other aspects, including business cycle and macroeconomic outlook are not taken into consideration.
A company-centric research though proves beneficial for the investor or fund manager. However at times, declining markets can pull the particular company stock down.
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