A top down approach definition is the act of seeking out securities by first looking at global economics, industry, and then individual companies. Finally, an investor finds an excellent security to invest in.
There are several different factors that are involved in a top down approach meaning. The top down approach analysis tries to incorporate all of these factors to try and find a best fit on a security that an investor is seeking.
Top Down Approach Factors
Those factors include the following:
1. Look at the Global Economy
A top down investor will first look at the global economy as a whole when conducting a top down approach. Different global economies affect a firm’s pricing and competition. Currency exchanges can have a large effect on this competition and should also be considered. If a firm is experiencing a lot of difficulty in competing in a country it conducts a lot of business in it may not be the best fit for an investor to buy the security.
2. Look at the Local Government and Economic Environment
The next step in the top down approach model is for an investor to look at the local government and economic environment of the best fit country. The best indicators to test the surface are by looking at the gross domestic product (GDP), unemployment rates, inflation, interest rates, and the budget deficit of the local government.
3. Indicate a Specific Industry
All of the factors above indicate a specific industry in which the investor might need to choose based upon the type of investment needed. Some industries perform better in certain economic environments than others. Based upon the conditions in steps one and two, you can choose the right industry. Industries might vary in their growth, volatility, and life cycles.
4. Choose a Specific Company
Finally, the last step is for an investor to choose a specific company within the industry. Investors want to pick a company considered in excellent condition. Perform this by doing a thorough financial analysis. In addition, gain opinions of several analysts who are familiar with the industry.
For example, the world economy is currently in a recession. However, Dwight has some money sitting in a bank account that he would like to invest in order to earn some sort of return. Dwight decides that he is going to follow a top down approach to investing to decide what security he should invest in and add to his portfolio.
Dwight first decides that he would like to invest domestically in the United States. This is because he believes the U.S. will bounce back sooner than most other countries. He then decides that he would like to invest in the oil and gas industry; it has historically been known to be a relatively recession proof industry and less volatile. After observing several different companies Dwight decides that he wants to invest in Chevco Inc.. Chevco Inc. has historically performed better than its peers even in recessions.
Note that using this approach does not always account for the desired return or deviation that an investor may want to take on or receive.