6.8 Top Down Approach and Bottom Up Approach
Fundamental analysis can be done in different ways or styles depending on the requirements, perceptions and anticipations of the individual doing the analysis. They can be classified as Bottom-Up Approach and Top-Down Approach.
What is a Bottom-Up Approach? It is the process of starting the analysis with a company and then going though a broader understanding of its influencing factors from micro to macro. In this approach, the industry and economic factors influencing the company have less significance than the factors related to the company. First, identify a company and then if satisfied about the company, analyse the other macro influencing factors to be able to take a decision.
Example 1: Let us assume that a person wants to invest in ICICI Bank. In this approach the investor will first analyse ICICI Bank and its financial strengths and then conduct a bigger analysis about the banking industry along with other factors like global recession, impact of external factors on the banking sector etc prior to taking a final decision about the investment.
What is a Top-Down Approach? It is the opposite of a Bottom-Up Approach and involves looking at the ‘big picture’ in the economy and the financial world and then breaking those components down into finer details. After looking at the conditions around the world, the different industrial sectors are analysed in order to select those that are forecasted to out-perform the market. From this point, the stocks of specific companies are further analysed and those that are believed to be successful are chosen as investments.
Example 2: In the new millennium, many foreign investors are interested in investing in India and China through Foreign Direct Investment (FDI) or Foreign Institutional Investment (FII). The important reason for domestic and foreign investors to do so is that India and China are flourishing with the highest GDP growth rates among them. In this case, the investors would analyse the economy and then identify particular sectors which may do well in the coming years because of India’s unique strengths and finally choose a company's shares to invest in.