Successful investors and traders analyze the stocks that they invest in and the stocks, currencies and commodities on which they trade futures. So-called macroeconomic forces like Russia’s invasion of Ukraine, China’s Covid lockdowns, inflation and the prospect of higher interest rates, and the prospect of global food shortages all drive the markets. However, every commodity is unique as is every company whose stock one buys or sells. Here is where bottom-up investing comes into play.
What Is Bottom-up Investing?
When an investor focuses on the specifics of a company more so than on the overall market that is bottom-up investing. A bottom-up investor looks at company fundamentals such as their revenue stream of their products and services and the likelihood that the revenue stream will increase in future years. The margin of safety of a company in the form of cash, low debt, factories and other assets, as well as strong brand names all serve to protect the stock during market downturns and are part of the analysis of bottom-up investing.
Bottom-up vs Top Down Investing
The advantage of bottom-up vs top down investing is that not all stocks respond the same to macroeconomic factors. While over-priced high tech stocks have fallen recently as the broader market has crashed stocks like Kellogg have gone up. Top down investing worked for many ever since the market climbed out of the hole of the Financial Crisis crash and has been problematic as negative investor sentiment has taken the Nasdaq, Bitcoin, and the broader market downward.
Bottom-up Approach to Investing
The bottom-up approach to investing works for investors who do their homework, understand the concept of intrinsic stock value, and focus on a few well-chosen stocks. Those who follow this path to investment profits do well to limit their portfolio of stocks to no more than half a dozen as they need to keep closer track of their investments than when they simply put money into a fund that tracks the S&P 500, Nasdaq, Dow Jones Industrial Average, or Russell 2000.
Bottom-up Investment Process
Long term, buy and hold investors commonly use the bottom-up investment process. They carry out fundamental analysis on stocks before buying and continue to assess fundamentals over time. These investors commonly buy stocks with long term value during market downturns when these stocks have been unfairly devalued due to widespread negative market sentiment. Warren Buffett bought $1 billion worth of Coca Cola stock in 1988 because he believed it was undervalued for the long term. By 2020 that investment had returned 1550% plus dividends.
Bottom-up Investing Example
Buffett’s purchase of $1 billion in Coca Cola stock is a prime example of bottom-up investing. The stock market crashed in 1987 taking both good and bad stocks down together. Coca Cola’s stock price fell but its brand name did not suffer. Fundamental analysis of Coca Cola showed investors that the company had a both a huge margin of safety as well as prospects for continued growth and increasing profits unrelated to conditions in the broader economy. Consumers in the real world buy Coca Cola products irrespective of how the stock market is doing.
Bottom-up Investment Strategy
The bottom-up investment strategy works for those who have the time and inclination to search for and investigate individual stocks. This approach can be extremely effective for retail investors who can use their own professional and business expertise to give them an advantage over traditional stock analysts. Peter Lynch wrote about how when Smith Kline & French marketed the first effective acid blocking drug for treating peptic ulcers. Physicians and especially surgeons realized that this breakthrough would totally change that niche of their practices and would be a huge market success as Tagamet became the best selling drug in the world.
Advantage of Bottom-up Investing
Top to bottom investing can provide handsome profits but the advantage of bottom-up investing is what there is where the potential investing home runs are. Back when IBM was the king of all computer-related things they missed out on desktop computers. Then they went to a small startup for the operating system for their personal computer or PC. That is what started Microsoft on its way to become an industry giant. A bottom-up investor who spotted Microsoft’s potential when it went public on March 13th, 1986 would have experienced a 1000-fold return on investment not counting dividends over the years. This approach to investing is similar to how we approach day trading at DayTradeSafe with skill and discipline to most effective enter, manage, and exit trades.