Methods of Stocking Pick

Before we look at the differences between top-down and bottom-up investing, let's make clear that these are both approaches for selecting great stocks. Despite the differences in their methods they have the same goal - to ferret out good stocks. Now, let's look at the different ways in which a top-down vs. bottom-down investor approaches selecting companies to invest in.

Top-down investing involves analyzing the "big picture".

• Investors using this approach look at the economy and try to forecast which industry will generate the best returns.
• These investors then look for individual companies within the chosen industry and add the stock to their portfolios.

For example, suppose you believe there will be a drop in interest rates. Using the top-down approach, you might determine that the home-building industry would benefit the most from the macroeconomic changes and then limit your search to the top companies in the industry.

Conversely, a bottom-up investor overlooks broad sector and economic conditions and instead focuses on selecting a stock based on the individual attributes of a company.

• Advocates of the bottom-up approach simply seek strong companies with good prospects regardless of industry or macroeconomic factors.
• What constitutes "good prospects", however, is a matter of opinion.
• Some investors look for earnings growth while others find companies with low P/E ratios attractive.
• A bottom-up investor will compare companies based on these fundamentals as long as the companies are strong, the business cycle or broader industry conditions are of no concern.

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