Bottoms Up Stock Picking

If someone was to ask you how much your house is worth down to the dollar, you probably couldn’t tell them, even though you live there and likely know everything there is to know about it. However, you could come up with a decent range of value for your home after doing a little bit of work looking at what comparable houses in your neighborhood are selling for.

Now, what if we asked you what the value is of all the houses in your city combined, or even just your neighborhood for that matter? You likely would be overwhelmed with the challenge as the answer is largely dependent on what a group of very different people would be willing to pay for different houses. There are simply too many pieces to the puzzle; too many moving parts.

This is analogous to investing in individual companies versus investing based on macro views. There are so many millions of moving parts to the global economic system that we find the odds of investing in individual companies much better. While no one can pin down the value of a business to an exact dollar amount, we can develop a reasonable range of what it is worth. Then we buy at a significant discount to that range. This exercise is too hard to do on a macro economy.

The process of examining individual companies first and working our way up to see its competitive position in the industry is called “bottoms-up” analysis rather than starting at the top level with macro forecasts and working our way down, which is referred to as “top down”. We are bottoms-up investors as we believe it provides the highest probabilities of success.

What we do keep an eye out for are significant changes to an industry. These industry specific issues may be driven by macro issues. For example, holding a significant amount of bonds/yield assets into a rising interest rate cycle would be imprudent. We have no idea when interest rates will rise but we are relatively confident that owning a lot of yield right now is a bad idea. That being said, if we find securities that are significantly mis-priced we will still purchase them despite some macro headwinds as the margin of safety in the purchase price offsets these headwinds.