Top Down/Bottom Up

You might have heard the expressions ‘top-down’ and ‘bottom-up’ applied to stock picking. Let us explain.


Top-down research is what the economists and strategists do. They try and predict where the equity market will go by working out what earnings are going to do on average over some time period. To do that they don’t look at companies. Instead, they look at higher-level economic inputs like GDP growth, inflation, currency rates, commodity prices, business and consumer spending.

The economists make their macro factor predictions and the strategists factor those into equity market equations and start telling you about how much the market will go up or down this year.

Whilst the strategists fill a lot of space and do a lot of marketing for their financial institution (they almost all work for one) the truth is that they don’t help you decide which stock and when and in so doing avoid responsibility. Their get out of jail free card for their credibility is considering every option, without telling you which. They do this by saying “If this happens then this” and “If that happens then that” they rarely actually tell you anything that helps you make money out of stocks.

They make a lot of noise because the media loves their space-filling commentary and their employers love the subliminal promotion of their intellect and hence their products and brand. But ultimately a large portion of macro strategy and economic debate is the study of history not a prediction of the future. What makes money is when the market is wrong and when you spot it in advance. Most strategic comment tells you what the market expects, not what it has got wrong and which stocks to buy to exploit that.

On that basis, most macro-economic comment is given much too much time and will waste yours… if you let it. It is primarily there for its marketing value, it makes an institution look smart to have a high profile strategist prognosticating on terribly complex issues and not only is it good for their brand, it more importantly calms and impresses clients. But if you think you’re going to make money from their predictions about where the ASX 200 index is going you are probably too optimistic. Top-down is what we “macro crap”, it’s interesting, it appears important (and is to certain people and professions), but it’s extremely time-consuming and of very little value add when you are looking to buy stocks, especially compared to picking and understanding individual companies.


Then there is bottom-up research. Analysts visiting companies, working out the earnings number for an individual company and determining the value of that company’s stock and deciding whether it is a BUY or a SELL. Simple stuff. Looking at the trees instead of the woods and clearly a process that adds a lot of value to the equity investor. The process of identifying stocks that have a higher probability of going up in price as opposed to making a lot of marketing based noise.

Bottom-up is what stock pickers do and if you are a typical 20 stock portfolio investor you should value anyone who does this, anyone who takes the time and makes the effort to have an opinion on a specific stock. The single best use of your limited attention span as a direct equity investor is not having some highbrow discussion over dinner about what Phillip Lowe just said or what Jerome Powell is going to do, it is in looking for stock ideas, stocks you can buy, stocks you can make money out of, because this is reality. Leave the grand discussion to others.

We read the efforts of anyone trying to pick stocks and suggest you do the same. They won’t all add value but there will be gold in some. I suggest you value the opinions of stock pickers even when they are wrong, because they are making an effort, adding value and stimulating ideas and opinion. Far more practical than reading a highbrow five-thousand word “macro crap” piece that comes to no useful conclusion and will not make you a dime. Talk about time-wasting.

For an investor in individual stocks you need to be looking at the trees not trying to predict the wood. Of course, you should keep the ‘market’ in your peripheral vision for moments when the herd takes over but in any normal market the money is in getting individual stocks right and that means bottom-up, not top-down.

Top-down is for institutional marketing purposes and helps you look smart at dinner parties. Bottom-up is for making money.

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