In this approach companies are always first analyze with respect to the activity of the economy and by trace economic trends to forecast the future. There are two types of factors which influence the share’s price. While certain factors are similar to all companies, there are a few that are particular to an industry or a company. For e.g. when changes makes in interest rate, it affects all sectors of an economy. Hence, these factors working at the macro level and micro level.
Macro Economic Factor:
The top down approach starts with the big picture i.e. studying the macro economics environment in which the economy is performing. In evaluating these factors, investors/fund Managers look at variables such as the growth rate of the economy, the prevailing interest rate scenario, political conditions and the regulatory environment among others. It is important to know today or more than ever, global factors have become very critical. It is not awkward to hear that because of some changes in government policies, Indian economy has been highly affected. It means that critical global issues borne in mind while evaluating the macro economics level in top down approach.
top down and bottom up approach
Scanning the sectors:
The other important thing is to decide on industries that hold long-term promise. In growing economic like India, certain sectors will shine brighter in the years to come. If industries connected with infrastructure, power and telecommunications are likely to do more well because they have attractive investment opportunities.
Identifying the companies:
The last step in top down approach is to selecting individual stocks based on fundamentals. The concept is to identify companies that are undervalued with their fair value. The company could be growing at a much faster rate.
Bottom up Approach:
It is totally opposite from top down approach, in bottom up approach investing stocks from micro analysis at the company level. In evaluation process, industry and economy both are evaluated. This approach believes that the fundamental strength of a company derive its shares prices and future return capacity. Even in a difficult phase of a economy or the stock market , a company with strong fundamentals would perform well. Bottom up approach attempts to identify that stock which have high aspects studied are management quality.
Further a bottom up approach looks at financial basic of the company which is at the core of its valuation. Past performance is measured by growth of topline and bottomline over a period of time is evaluated.
Selection of stock is followed by a forecast of industry prospects and general economic conditions by looking at factors i.e. GDP Growth, index of industrial production, current rate of interest in the economy and the rate of inflation.
The concept is that if a stock has strong fundamentals, then it would perform well in all conditions.
Conclusion:
In short, the above information explains top down and bottom up approach in all ways. In practice, a blend of top down and bottom up approach would work to your advantage.
As we know, every style has its own advantages as well as disadvantages to each other. Similarly, top down approach and bottom up approach have its own advantages and disadvantages.
