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Stockpicking Part 2 - Bottom Up Analysis

February 25, 2012 | Comments: 0 | Views: 185

Bottom Up Analysis

When it comes to stockpicking - choosing which stocks to invest in and trade - there are many different techniques which have proved successful in the stock market. The most important thing is to consider as many as possible, and find the ones which work best for you. A top down approach is the process of finding a broad area of the economy you think will perform well and then finding the best stock in that sector. This is useful for those with big picture views that are often unsure how to create a trading strategy or trading model based on them, but it doesn't work for everyone.

A bottom up approach focuses on the attributes of an individual stock and decreases the emphasis on the wider economic picture. The concept is that a good company can perform well even if its industry, or the global economy, is performing badly. This may be the result of its large cash balance, strong growth rate or quality management. The methods which you use in order to select your chosen company(s) are up to you, but a good amount of top tier research is recommended. Consider reading stock broker reports on the company, previous ASX announcements and analyse its annual report in order to get a good idea of its financial position and where it might be heading.

An example of choosing a company through a bottom up analysis would be as follows. Apple (AAPL) is a technology based company in America, and as such doesn't look to be placed too well. The US is only just recovering, technology stocks suffer when consumer demand falls and the global economy has been struggling the last few years. But this would all be put aside whilst the fundamentals of Apple are considered. For the record, Apple's share price has increased 160% since its GFC high and 500% since its GFC low, in comparison to the S&P only just recording the same level as it was before the crisis.

You may have decided that the most important decision making factors to you were experienced and innovative management, strong organic (internal growth, not by acquiring companies) growth rate and a product which could increase its market share. Apple were lead by the late Steve Jobs, the founder of the company, who has a proven track record of creating quality products to match the needs of the era. Apple's revenue has grown by more than 20% every year but one since 2007 (as seen on the graph below), suggesting that they would perform strongly regardless of what was happening in the industry around them. Finally, they have a range of products that appeal to a vast number of people, have multiple uses in society, and are yet to find their way to the majority of aforementioned targets.

The combination of these factor would lead you to invest in Apple, regardless of what may be going on in the technology sector or broader economy around it. This is stockpicking at its purest - choosing those companies on the stock market which will outperform those around it. It takes some skill and a fair amount of research, but the rewards are worth it when you can successfully filter out the great from the good.

I trade at an investment bank and have traded global FICC and Australian equities from my own account for the past few years. I have outperformed the MSCI each year, and focus on global macro and momentum based strategies. You can read my trading strategies and views at: http://www.pimmtrading.blogspot.com

I have also created a blog to help those learning to trade and invest, which details the tips and mistakes that I have learnt along the way. This can be found at: http://www.tradingpimm.blogspot.com

Hope you enjoy reading them!

Source: EzineArticles
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