Top-down Approach vs Bottom-up Approach: What Should You Choose?

After you understand the basic working and function of share market, you will have other question. The question is 'How to select the company in Indian share market or other share market in the world'. Many investors who just enter share market world will ask these questions frequently.

To find the best company's stock, you can choose Top-down approach or bottom up approach. Many see both top-down and bottom up as same. But they are completely different. You can apply this approach in various fields like investing, management discussion, project work, etc. This article focus on investing in share market. By the end of this article, you can learn the answer for following question. 

1. What is Top-down approach investing?
2. How can you apply Top-down approach to find the company stock with example? 
3. What is bottom-up approach investing?
4. How can you apply bottom-up approach to find the company stock with example? 
5. Difference between these two approaches?

What is Top-down approach investing?

Top-down approach is seeing from the top of building and narrow down to specific things. In investing, top-down approach starts from macroeconomic and narrow to the particular sector and then to the particular company. 

For example, you are new to the investment field and you decide to invest. Basically, where will you start from?. First you need to find the best growing country to invest. There are many macroeconomic factors which may determine the growing country like having good GDP, good political parties, having good inflation rates, having specific schemes like 'made in India or china' etc. 

From analysing the market as a whole, you will find the best country. After that, you see that particular country (say India) and India may improve and benefit the particular sector with scheme and incentives. You find the particular sector. In this sector, there are many companies or industry. After comparing that industry with its peers industry, you can find the best company's stock. This way of finding the company's stock is called top-down approach. 

How can you apply this approach to find the stock with example? 

You know that we are facing the pandemic across the global in 2020. As a top-down approach investor, you find that there are many people who are suffering from the corona virus and they need medicine and doctors. So, you narrow the entire economy into a particular sector (here Pharma sector). Now, you know pharma sector have best company stocks/securities. 

After that, you will compare the several companies in the particular industry and going to find the best in it. You can do fundamental analysis to find the best company in pharma sector. Like wise, when macroeconomic factor of country like GDP, inflation rates share market growth does well, bank sector may do well and then you can find best bank stock. 

Advantages of Top-down approach investing:

• It can easily apply to find the stocks like analysing the macroeconomic factor etc., 
• Best method for trades and short-term. 

Disadvantages of Top-down approach investing:

• It doesn't apply for long-term investor. 
• When pandemic is over, the pharma sector may/may not increase. It causes a problem to the investor who choose top-down approach. 
• It gives much importance to macro economy and sector but not the company.

What is Bottom-up approach investing?

This approach is inverse of top-down approach. But this approach gives different company and different stock. Bottom-up approach gives more importance to individual companies rather the economy or sector. 

If you choose this approach, analyse the individual companies first and compare with peers. Individual companies should have good management, good brand, good Audience, good operating margin, good future growth etc., compare to its peers industries. After that, you should analyse the particular sector and its development. At last, analyse the macroeconomic factor like GDP, inflation rate etc.

This approach is like believing more in particular company rather than sector. Whenever recession happens, this company chosen from bottom-up approach may not affect much from the recession. Because we give more weightage to the particular company rather  than economy. 

How you can apply bottom-up approach to find the company’s stock with example?

One of the best examples of the bottom-up approach is Coca-Cola. Coca-Cola has been operating since 1892. This company have wide moat characteristic (good brand name, consumer product, steady audience). Besides this moat, the company operated in almost all the country in the world. The company has good management and good operating margin. You should analyse the individual company more. 

Coca-Cola is a consumer goods, and it comes under fast-moving consumer goods (FMCG sector). People buy these products rapidly. So, it needed even the recession happens. Recession and pandemic also affect the coca-cola but not much. Like wise, you can select the company that have good moat characteristics and management. This company will run long when you choose correctly. 

Advantages of Bottom-up approach investing:

• Long-term benefit for an investor. 
• Company does not affect much from economic factors like GDP, inflation rates. 

Disadvantages of Bottom-up approach investing:

• When company does not well, it affects investor very much. 
• It takes very much time to find the company’s stock by using this approach. 

Top-down vs bottom-up a difference:

The difference between these two approaches is giving importance to what. Top-down approach investing gives importance to economy and sector while bottom-up approach investing gives importance to individual company.  In the top-down investing approach, you choose company based on GDP, inflation scheme but still analyse individual company. In the bottom-up investing approach, you choose company based on moat, management, margin of individual company but still analyse macro trends and economy. 

What you should choose- the conclusion:

From my perspective, I think if you choose a top-down approach, the company does not withstand for a long period. If the macro trend change or sector growth change, then it may fall. But you can choose top-down approach if you are a trader. You choose bottom-up approach investing if you are an investor. You should choose a company that should withstand any change in macro trends, economy factor etc., 

You are investing in the company’s stock not macro trends. So, gives importance to particular company and its management rather than economy. It is difficult to find company based on bottom-up approach. When you find it, you should invest definitely. For video, refer this.

As you know about top-down and bottom-up approach investing, which approach do you want to choose?