There are many investment strategies you can implement in your financial planning. Bottom-up investing is an investment strategy that prioritizes and focuses on individual companies and their fundamentals. Here are some things you should know about bottom-up investing before you decide to take this approach.
Microeconomics vs macroeconomics
A company’s ability to succeed can often be strongly influenced by the success (or lack thereof) of its respective industry and by the economy in general. The aspect of the economy that investors focus on is what separates bottom-up and top-down investing.
Macroeconomics examines the economy on a broad scale, which can include national and even global perspectives. Those looking at macroeconomics might look at things like inflation, unemployment, government policies, gross domestic product, and other factors that can affect a stock. Microeconomics, on the other hand, examines the economy behind businesses and individuals.
Business fundamentals to consider
Bottom-up investing involves focusing on microeconomic factors, with an emphasis on the fundamentals of a business. Since bottom-up investors generally believe that a business with strong fundamentals can thrive regardless of what happens in the wider market, it is important to have a thorough understanding of the business, especially its health. financial.
Financial statements such as balance sheets, cash flow statements, and income statements provide an overview of a company’s financial position. For example, a company’s balance sheet will tell you how many assets and liabilities it has and give you an idea of the value of the business. A company with too many liabilities could be a red flag for some investors.
Investors can also look at a company’s income statement to see its income and expenses and whether the company made a profit or made a loss. This information is useful in determining a company’s price-to-earnings (P / E) ratio, a very useful number in determining whether a stock is undervalued or overvalued compared to similar companies.
In addition to financial health, bottom-up investors should have a good understanding of a company’s leadership team, its product and service offerings, its competitive advantages, and its potential for growth. Having an in-depth knowledge of these details can help investors consider several aspects of the business and spot potential flaws that could make it a bad investment.
For example, if a CEO has a history of corporate corruption or bankruptcy, you probably want to know that before you invest. Likewise, if a company’s main product or service is not patented and easily reproducible, you should take this into account as it will likely hurt its competitive advantage.
The disadvantages of bottom-up investing
While it is important to understand how a business works, its product and service offerings, and its financial health, it is not always wise to make investment decisions based entirely on these factors. Completely ignoring broader macroeconomic factors can cause an investor to miss out on something that, while perhaps not currently, could negatively impact a company’s growth potential in the future. For example, if a business is in a highly regulated industry, such as healthcare or finance, changes in government policy can affect how a business operates.
Identifying and finding individual businesses can also be more difficult for new investors who may not be familiar with financial statements and what to look for in a business. Unlike index funds, which allow you to invest in multiple companies at once, investing in a sole proprietorship does not offer instant diversification, which is one of the cornerstones of a good investment strategy.
You can have multiple strategies
While bottom-up investing focuses heavily on specific companies and their fundamentals, that doesn’t mean that other macroeconomic factors are entirely ignored – they just aren’t the most important aspect. If you are interested in bottom-up investing, you don’t have to focus solely on bottom-up investing; you can use a balanced approach that combines bottom-up and top-down investment strategies. Either way, investing with a plan will put you in a better position to meet your financial goals.