Top down versus Bottom up; value v growth

There are two distinct ways of selecting securities.

If you adopt a “Top-down” approach you select securities by first forecasting the overall economic environment and determine the likely best performing industries in that environment. There is an inherent assumption that the performance of individual shares will be more greatly influenced by their common sector background than the individual talents of the company management.

The attraction of this approach in its purist form is that one can manage a global portfolio in this manner. Thus having predicted an environment of a demographically ageing population and rising living standards a top down approach would argue correctly that a high weighting to the global pharmaceutical industry should be maintained. A prediction that the oil price will fall to 20 year lows leads to an avoidance of all oil stocks until it has done so regardless of individual merit.

For example, I retained Qantas within the DirectPortfolio Imputation portfolios during the Asian crisis of late 1997 and through 1998 despite cries to sell from every broker I spoke to. In the end, as in the seventies, Qantas and other global airline company shares responded positively to the fuel savings as they are one of the major beneficiaries of falling oil prices.

A “bottom-up” approach concentrates on selection by analysing the individual companies and comparing relative value. In practice it is impossible to form a judgement without having a top-down view as well. Likewise a top-down approach should be enhanced by individual Security Analysis. For example, the selection and retention of Qantas was largely a belief that the chief executive, Mr James Strong, would deliver on his stated aim of cost savings and adjusting routes to optimise traffic. The fact that the management team were able to so successfully change flight routes to cater for higher European and US traffic to Australia and les from Asia was a testament to the quality of the management team then. Oh they were the days…..

Value versus Growth

Value based approach
The value based approach is designed to buy shares when they are intrinsically or relatively cheap. Ideally the company is trading at a discount to its net asset value, has experienced a one-off temporary fall in earnings which has eroded its rating, or is simply out of favour but likely to become more favoured over time.

If you limit your buying to times when shares appear pure bargains then you run the risk of missing many opportunities too. Many opportunities only become apparent over time, as the holding matures. A value based approach

Growth approach
A growth approach is based on finding companies which will grow their earnings strongly over the years with the ideal intention of sitting back and enjoying the ride. The paramount growth stock story in Australia was probably Westfield Holdings. Macquarie Bank is another good example. A good example of reverse growth would be the AMP that listed in the eighties and has gone backwards ever since.
Technical Charting

As soon as you buy, indecision is no longer possible. You must evaluate your decision over time, and decide whether to sell or hold on. Almost by definition, your success rate in decisions to sell or hold on will be less than each cautious buy decision. Agonising over a holding which is falling or stagnant and possible opportunity foregone.