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Top-down or bottom-up approach (自下而上或者自下而上的选股法)

When investors come to selecting good companies, there are various choices. Some people may look at PE ratio and choose the company with lowest PE ratio, some may choose the company based on the RSI indicator, where they choose companies that are oversold and hope for a rebound before selling them. However, fundamentally, there are two approaches to select a company, which are top-down approach and bottom-up approach.

First, let us talk about top-down approach. The first step shall be choosing the economy or country to invest, in order to choose the economy or country that will have the better growth compared to others. After that, you need to choose the sector to invest in, may it be medical, technology, food and beverages or retailers. This is to see which sector can grow the fastest or which sector will be the near future trend. Then, only you proceed to choose the company, on which company is the best out of the bunch. For example, you expect that glove sector will do well in 2020, and after confirming the sector, then you will proceed to choose the company, which may end up let say be, TOPGLOV. That’s what we call top-down approach.

On the other hand, bottom-up approach is to first select a group of companies that have a very strong fundamental, may it be cash flow, profit margin or growth potential. When doing this step, we will not consider what sectors are these companies in yet, where all we need is a strong company. After filtering all these companies, then we will only look at their sector on which sector works the best in terms of growth prospect. Let say 900+ companies in Malaysia, and you are able to find 50 companies that are fundamentally strong and stable, then maybe 8 out of 50 are within a good sector. Hence, your selection will be within these 8 companies.

So, you will ask which is the best to use? However, there is not an exact answer to it, you can use either approach to select your company or stock to invest. It can also change based on the situation. For example, when glove is booming back in May 2020, we then can use top-down approach, to choose which glove company to invest. On the other hand, if a bear market approach, we can use bottom-up approach to choose a few best out of the best stocks so that we can gain much more when the market rebound.

In short, there is no fix approach to which investors should use, it shall be up to the investors’ selection and mind-set, followed by the current and future trend. However, knowing these two options allow you to be flexible in the future when comes to stock selection.






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