What is top down versus bottom up investing?

The main aim of any investment strategy is to generate enough returns to help you achieve your goals in an appropriate time frame. But where do you start your search for shares?

There are many different ways to assess shares, from size, industry or correlation to the wider economy, as well as more complicated approaches, known as fundamental analysis.

Two different approaches to identifying shares that might suit your requirements are known as ‘top-down’ or ‘bottom up’ investing.

Top-down investing

This starts by looking at the big picture, including political, social, economic and technological conditions at home and abroad.

A top-down investor might look at the outlook for the Australian economy, as well as those of major trading partners like China and Japan. They might also look at current economic indicators like employment figures, inflation and interest rates, or new technologies that are changing consumer habits.

This process might unearth broad themes that will impact particular market sectors.

An example of a theme might be the expectation that the Australian dollar will fall in the near future.

This could be considered good news for export oriented sectors like tourism, manufacturing, agriculture, energy or materials, whose goods and services become more affordable for overseas buyers when the domestic currency is cheaper, prompting a rise in demand.

If you decide on a sector you think could do well during your investment timeframe, then you would analyse the companies within it to determine if any could add value to your portfolio.

Bottom-up investing

The bottom-up investor starts with specific companies, believing that the right ones will grow over time, regardless of what the rest of its sector or industry is doing.

If you use this method, you would hone in on a company to learn more about its products or services, recent developments and future plans to better understand how it has and, more importantly, will make its money.

You would then want to assess its competitive position within its market, its level of debt, the amount of cash it has available to spend, whether it pays a dividend, whether its earnings are growing and sustainable, and how its shares have been performing.

This would enable you to make a more informed decision about whether or not shares in the company would be the right fit for your investment portfolio.