Bottom Up Investing for a Diversified Portfolio

Ready to ¬†build a portfolio from the ground up? Let’s get into bottom up investing. Bottom up investing is a way to research stock picks for your portfolio. Most people are already familiar with bottom up investing. It’s the type of investing and research that Warren Buffett does. It focuses on the idea that a solid company can do well no matter the environment. It’s the opposite of top down investing. With top down investing, you first examine the macroeconomic picture and then decide what sectors will do best. Once you have the sectors that will do best given the current environment, you then narrow down to the best stocks in that sector. So you are placing business cycle bets and sector bets. Bottom up investing starts instead with the companies that should do well no matter what the economic cycle.

How to Pick Top Performers

This is probably one of the most asked questions in the investing world. How can you pick winning stocks? Should you look for stocks that have been winning in the past or should you choose companies that will do well or even better going forward? Well, if you are bottom up investing, you will want to look at companies that have done well in the past and also have the potential to continue their growth story. There are a few ways to analyze top stocks.

Financial Statement Analysis

Analyzing financial statements is an important part of bottom up investing. You will want to look at cash flow, revenue and expenses. You also should be able to check a few ratios as well to compare the performance of the company over time and across competitors. A good way to do a quick analysis is to use a page with key financials like the one at Yahoo Finance. They show the ratios that most people are looking for and they also show a table with comparisons of major competitors so you can evaluate the strength of the company.

Products and Services

Another characteristic of bottom up investing is the analysis of the company’s products and services. If a company is working to increase lines of business and managing their business efficiently this company would be a candidate for further research. There are different factors that you would look at for a manufacturing company versus what you would be interested in learning about a more service based company.

Cash Flow Management

Every investor knows that cash is king. A company that makes good decisions with their cash is well positioned for opportunities that come their way. They are also in a better position if they were to hit a slump where the revenue were to slow for a bit. There are two main ways you can evaluate a company’s cash flow and that is working capital and free cash flow to the firm. Working capital is what is left after current liabilities are subtracted from current assets.

Insider Trading

Another good metric to pay attention to when you are evaluating a company in a bottom up manner is the activity of trading by upper level management. Are you seeing insider selling by management. That is usually not a positive sign. What you really want to see is a high level of ownership from management. That means they have some skin in the game and you can be sure that they feel the same as you, because as a fellow investor, their goal is to see price appreciation for their investment.

Are you using bottom up evaluation to choose your stocks? How do you evaluate an investment before you make a purchase?

This post was written by Latisha.


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