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Top-down Approaches for Investors Equity research , Anik
Ahmed
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Top-down Approaches for Investors Equity research
Difference between "top-down" and "bottom-up" investing:
Before we look at the differences between top-down and bottom-up
investing, we should make it clear that both of these approaches
have the same goal - to ferret out great stocks. Now, let's look at
the different strategies used by top-down vs. bottom-up investors
to select companies in which to invest.
Top-down investing involves analyzing the "big picture".
Investors using this approach look at the economy and try to
forecast which industry will generate the best returns. These
investors then look for individual companies within the chosen
industry and add the stock to their portfolios. For example,
suppose you believe there will be a drop in interest rates. Using
the top-down approach, you might determine that the home-building
industry would benefit the most from the macroeconomic changes and
then limit your search to the top companies in that industry.
Conversely, a bottom-up investor overlooks broad sector and
economic conditions and instead focuses on selecting a stock based
on the individual attributes of a company. Advocates of the
bottom-up approach simply seek strong companies with good
prospects, regardless of industry or macroeconomic factors. What
constitutes "good prospects", however, is a matter of opinion. Some
investors look for earnings growth while others find companies with
low P/E ratios attractive. A bottom-up investor will compare
companies based on these fundamentals; as long as the companies are
strong, the business cycle or broader industry conditions are of no
concern.
A Top-Down Approach To Investing :
An area that most investors struggle with is the art of picking
stocks. Should they base their decisions solely on what the company
does and how well it does it? Or should investors be more concerned
about larger macroeconomic trends, such as the strength of the
economy, and then determine which stocks to buy? There is no right
or wrong answer to these two questions. However, investors should
develop systems that help them to achieve their investment goals.
The second option mentioned is referred to as the top-down
investing approach to the market. This method allows investors to
analyze the market from the big picture all the way down to
individual stocks. This differs from the bottom-up approach, which
begins with individual stocks' fundamentals and eventually expands
to include the global economy. This article will concentrate on the
process used when investors implement the macro-to-micro style
referred to as the top-down approach.
Start at the Top: The Global View
Because the top-down approach begins at the top, the first step
is to determine the health of the world economy. This is done by
analyzing not only the developed countries of North America and
Western Europe, but also emerging countries in Latin America and
Asia. A quick way to determine the health of an economy is to look
at the amount of gross domestic product (GDP) growth of the past
few years and the estimates going forward. Oftentimes, it is the
emerging market countries that will have the best growth numbers
when compared with their mature counterparts.
Unfortunately, because we live at a time in which war and
geopolitical tensions are heightened, we must not forget to be
mindful of what is currently affecting each region of the world.
There will be a
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Top-down Approaches for Investors Equity research , Anik
Ahmed
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few regions and countries throughout the world that will fall
off the radar immediately and will no longer be included in the
remainder of the analysis simply due to the amount of financial
instability that could wreak havoc on any investments.
Analyze the Trends:
After determining which regions present a high reward-to-risk
ratio, the next step is to use charts and technical analysis. By
looking at a long-term chart of the specific countries' stock
index, we can determine whether the corresponding stock market is
in an uptrend and is worth taking further time to do some analysis
on or is in a downtrend, which would not be an appropriate place to
put our money at this time. These first two steps can help you
discover the countries that would match your wants and needs for
diversification. (Need more information? Read Trader's Corner:
Finding The Magic Mix Of Fundamentals And Technicals and Charting
Your Way To Better Returns.)
Look to the Economy:
The third step is to do a more in-depth analysis of the U.S.
economy along with the health of the stock market in particular. By
examining the economic numbers such as interest rates, inflation
and employment, we are able to determine the current strength of
the market and have a better idea of what the future holds. There
is often a divergence between the story the economic numbers tell
and the trend of the stock market indexes.
The final step in microanalysis would be to analyze the major
U.S. stock indexes such as the S&P 500 and Nasdaq. Both
fundamental and technical analysis can be used as barometers to
determine the health of the indexes. The fundamentals of the market
can be determined by such ratios as price-to-earnings,
price-to-sales and dividend yields. By comparing the numbers to
past readings, it can help determine whether the market is at a
level that is historically overbought or oversold. Technical
analysis will help ascertain where the market is in relation to the
long-term cycle. Use charts that show the past several decades and
zone down the time horizon to a daily view. For example, indicators
such as the 50-day and 200-day moving averages are used to help us
find the current trend of the market and whether it is appropriate
for investors to be invested heavily in equities. (To read more
about fundamental analysis, see Advanced Financial Statement
Analysis.)
So far, our process has taken a macro approach to the market and
has helped us determine our asset allocation If, after the first
few steps, we find that the results are bullish, there is a good
chance a majority of the investment-worthy assets will be from the
equities market. On the other hand, if the outlook is bleak, the
allocation will shift its focus from equities to more conservative
investments such as fixed income and money markets.
Microanalysis: Is This Investment Right for You? Deciding on an
asset allocation is only half the battle. The next integral step
will help investors determine which sectors to focus on when
searching for specific investments such as stocks and
exchange-traded funds (ETFs). Analyzing the pros and cons of
specific sectors (ex. health care, technology and mining) will
narrow the search even further. The process of analyzing the
sectors involves tactics used in the prior approach such as
fundamental and technical analysis. In addition to the mentioned
tools, investors also must consider the long-term prospects of the
specific sectors. For example, the emergence of an aging baby boom
generation over the next decade could serve as a major catalyst for
sectors such as healthcare and leisure. Conversely, the increasing
demand for energy coupled with higher prices is another long-term
theme that could benefit the alternative energy and oil and gas
sectors. After the entire amount of information is processed, a
number of sectors
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Top-down Approaches for Investors Equity research , Anik
Ahmed
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should rise to the top and offer investors the best
opportunities. (To learn more about the different industries, see
our Industry Handbook.) The emergence of ETFs and sector-specific
mutual funds has allowed the top-down approach to end at this level
in certain situations. If an investor decides the biotech sector is
an area that must be represented in the portfolio, he or she has
the option of buying an ETF or mutual fund that is composed of a
basket of biotech stocks. Instead of moving to the next step in the
process and taking on the risk of an individual stock, the investor
may choose to invest in the entire sector with an ETF or mutual
fund.(For more insight, see How To Use ETFs In Your Portfolio and
Advantages Of Exchange-Traded Funds.) However, if an investor feels
the added risk of selecting and buying an individual stock is worth
the extra reward, there is an additional step in the process. This
final phase of the top-down approach can often be the most
intensive because it involves analysis of individual stocks from a
number of perspectives. Fundamental analysis includes a variety of
measurements such as price/earnings to growth ratio, return on
equity and dividend yield, to name a few. An important aspect of
individual stock analysis will be the growth potential of the
company over the next few years. Ideally, investors want to own a
stock with a high growth potential because it will be more likely
to lead to a high stock price. Technical analysis will concentrate
on the long-term weekly charts, as well as daily charts, for an
entry price. At this point in time, the individual stocks are
chosen and the buying process begins. The Positives of Top-Down:
The proponents of the top-down approach argue the system can help
investors determine an ideal asset allocation for a portfolio in
any type of market environment. Oftentimes a top-down approach will
uncover a situation that may not be appropriate for large
investments into equities. The ability to keep investors from
over-investing in equities during a bear market is the biggest pro
for the system. When a market is in a downtrend, the probability of
picking winning investments drops dramatically even if the stock
meets all the required conditions. When using the bottom-up system,
an investor will determine which stocks to buy before taking into
consideration the state of the market. This type of approach can
lead to investors being overly exposed to equities and the
portfolio will likely suffer. Other benefits to the top-down
approach include the diversification among not only top sectors,
but also the leading foreign markets. This results in a portfolio
that is diversified within the top investment worthy sectors and
regions. This type of investing is referred to in some small
circles as "conversification", a mixture between concentration and
diversification. The Not-So-Positives of Top-Down Investing: So
far, the top-down approach may sound foolproof; however, there are
a few factors investors must consider. First and foremost, there is
the possibility that your research will be incorrect, causing you
to miss out on an opportunity. For example, if the top-down
approach indicates that the market is set to continue lower in the
near future, it may result in a lesser exposure to equities.
However, if your analysis is wrong and the market rallies, the
portfolio will be underexposed to the market and will miss out on
the rally gains. Then there's the problem of being under-invested
in a bull market, which can prove to be costly over the long term.
Another downfall to the system occurs when sectors are eliminated
from the analysis. As a result, all stocks in the sector are not
included as possible investments. Oftentimes there will be a leader
in the sector that is overlooked due to this process and
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Top-down Approaches for Investors Equity research , Anik
Ahmed
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will never make its way into the portfolio. Finally, investors
could miss out on "bargain" stocks when the market is near lows.
Find What You've Been Looking For: In the end, investors must
remember there is no single approach to investing and that every
approach has its own pros and cons. One of the keys to becoming a
successful long-term investor is finding a system that best fits
your goals and objectives. Maybe the top-down approach is just what
you've been looking for.
Fundamental Analysis
Fundamental analysis attempts to understand and predict the
intrinsic value of stocks based on an in-depth analysis of various
economic, financial, qualitative, and quantitative factors.
How It Works/Example: Fundamental analysis observes numerous
elements that affect stock prices such as sales, price to earnings
(P/E) ratio, profits, earnings per share (EPS), as well as
macroeconomic and industry specific factors. Fundamental analysts
use either top-down or bottom-up methods of analysis, or sometimes
both. A top-down analysis might function in the following
manner:
1) The entire market is analyzed, including global and
macroeconomic indicators 2) The specific sector, such as Technology
3) The industry, for example semiconductor manufacturers 4) The
specific stock, for example company ABC Conversely, a bottom-up
analysis starts by investigating specific stocks first. The
fundamental analyst observes trends, market and price movements,
company financial statements, interest rates, return on equity
(ROE), and numerous other indicators with one goal in mind: buying
or selling stocks that will provide a high return on investment
(ROI)
Why It Matters: Fundamental analysis, like technical analysis,
attempts to predict which stocks are valuable and which are not.
According to its proponents, fundamental analysis offers a fuller
picture of the possible movements of both the stock market and
individual stocks because as many elements as possible are
investigated. Technical analysis, on the other hand, only looks at
past data of stock prices. Perhaps the greatest argument in favor
of fundamental analysis can be made by observing the success of one
of its most famous proponents: Warren Buffett.
This is the another approach to analysis of Investors equity
research. As I given a demo executive summary previously and
included some basic idea about Alpha, Asset allocation, delta model
and security choices procedures. Now here I have given the most
effective way to select the stocks in a right time and technical
way which would help u to add value in preparing the case summary.
Keep making your proposal in a innovative way. Keep in mind that
you are the master of yourself and you are the legend of our
department.
Best of luck Anik Ahmed
BBA 3rd Batch, Department of Finance, JnU.
Email: [email protected], mobile: 01911292663
