Investment Strategies: Top-Down versus Bottom-Up
Deciding what companies to invest in is no light task. When entrusting your hard earned money to a company's stock, you must do your due diligence to ensure that you are comfortable with the company's operating strategies and level of risk. Before getting in to the nitty-gritty, you should decide on a handful of companies to analyze before spending a significant amount of your time researching them. Two common strategies for picking possible companies to invest in are the top-down and bottom-up strategies, which each having their one benefits and shortcomings.
The top-down strategy starts off with an overview of the total economy as a whole. When looking at the global economy, you'll want to also look in to the national economy as well, as a country that, for a very general example, has an abundance of a specific natural resource, might have better performing companies that process and distribute that natural resource, versus a country that is lacking in it. Going off the natural resource example, one should also take in to account the global demand for that resource as well.
Economy -> Sector -> Company
After analyzing the states of the global and national economy, you should have a better idea of which sector you might want to invest in. This could range anywhere from agriculture to tech. Ideally, you should look in to an industry that you have some knowledge of already, or at least a good level of interest in. This will make the research into the respective companies more enjoyable.
Once you have a really good understanding of the sector of your choice and how it behaves relative to the global economy, you can begin to analyze a handful of companies and do a thorough review of their operations and statements. Most of, if not all, of this information can be found on the investor relations page on every company's website. Analysis and comparison of each company will help you decide which one to invest in, if any at all. Don't be surprised if you end up not wanting to invest in a company that you did copious amounts of research on. Ignore sunk-cost fallacy and realize that all that time could have saved you from making a bad investment. It is important to perform your due diligence when it comes to something as risky as investing in the stock market.
The bottom-up strategy includes all of the same steps, except in the reverse order. Analysis begins at the company level, and then moves up the chain to the global economy. This method is not always recommended, because you are often focusing on a company or companies that may have been getting a lot of hype in the public recently, and is prone to confirmation bias.
Company -> Sector -> Economy
If you find yourself interested in a specific company, then the next step is to examine the overall health of the industry it operates in. If research in to the industry and sector shows that the investment may be worth the risk, then the last step is to determine if the company is worth investing in to in relation to the current national and global economy. Remember that if, at any point, your company in question does not pass its analysis, it is ok to move on and begin your search elsewhere. Only make investments with companies that have passed your analysis and if you are comfortable with the level of risk involved.
Disclaimer: This article is not financial advice and is intended only for educational purposes. Investments are not FDIC insured and carry risk. Please check with your brokerage for more information.