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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

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-toearnings, 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

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 ExchangeTraded 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

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: anikahmed21@yahoo.com, mobile: 01911292663