I was talking to a friend about investing the other day and was questioned when I used the expression “bottom up investors.” (As an aside, I love to talk about investing. I try to be very selective about who I do this with – because I get excited, start talking fast, acting manic. None of us wants anyone to know how crazy we are. The truth is, most of the people I know aren’t as interested in the topic as I am, so I have to try to keep myself in check. My wife is the one who suffers – I don’t hold back with her;) I tried to explain, essentially, what I think it means to be a bottom up investor (not to be confused with a “bottoms up investor” – that is, one who finishes his or her drink before making an important investment decision. I kid.)
You can basically categorize most investors as either “top-down” or “bottom-up,” (or, perhaps – macro vs. micro). Top down investors make their decisions after evaluating large economic conditions (macro conditions). Based on their analysis, they try to identify particular sectors and industries that they believe will do well based on their view of the broader economy. Only after this step do they move on to individual investment opportunities. These are the investors you’ll find talking about the business cycle and longer term trends in things like technology.
Bottom up investors, on the other hand, believe that it is easier to be correct about a particular company than about the broader economy. For this reason, they don’t spend a lot of time forecasting the economy. Most bottom up investors don’t believe this is a prudent way to spend your time. There are, after all, so many variables that impact the broader economy – interest rates, commodities prices, inflation, natural disasters, political instability…just to name a few. Not many people are going to be experts in all of those things, or for that matter, have a working understanding of all those things.
Not only do top-down investors need to be right about their projection – they need to be right before their competitors are. If you aren’t – prices are going to be bid up to a level that reflects the underlying belief you’d like to make your investment on.
Plus, what happens when top-downers are wrong? What if they believe that interest rates (or inflation, or anything) is going down and it goes up? What then? Is that the time to abandon your investments? It would probably be time to re-evaluate your analysis and why you were wrong, but what’s your next move?
For bottom-up investors, if you decide that your investment thesis is still accurate, and the price goes down, or macro events surprise us – we can simply buy more of the company that we’ve become knowledgeable about. If the stock was undervalued at $18 a share, it’s an even better buy at $15 per share – assuming that the underlying information that you based your decision on hasn’t fundamentally changed.
For these reasons, most value investors tend to consider themselves “bottom-up” investors. Ben Graham, Seth Klarman and Michael Price would all fall into this category. Of course, the two aren’t necessarily mutually exclusive. You can be a little of this and a little of that. That’s how I would classify several famous investors like Peter Lynch, Ken Heebner, Bill Miller, David Einhorn and perhaps even Warren Buffett. Jim Rogers is an example of someone that I would consider extremely top-down (another famous example would be the Hunt brothers 
A word on throwing Buffett into the hybrid category: I’m pretty sure Buffett would call himself a “bottom-up” investor (Buffett would actually probably think these classifications are a waste of time;). While many of his investments have been of the bottom-up variety, his (BRK-B‘s) most recent (and largest ever) investment involved the purchase of a railroad. This appears, to me at least, to be more of a top-down investment, for several reasons. For one, Buffett himself refers to this investment as an “all-in bet on the US economy.”
The question, then, becomes, what exactly is he betting on? To me, and I’m not going to pretend to know what Buffett is thinking (aside from what he says), this appears to be a bet on two things: (1) long term economic prosperity in the US – which would in turn increase demand for commodities, many of which are primarily shipped by rail (especially coal**), and (2) a long-term bet that the price of oil will remain high, which matters because the already steep advantage that rail has over trucking in terms of energy costs. The question in this analysis is that if he believes #2, why would he be decreasing positions he currently holds in energy companies (XOM and COP) in order to finance this acquisition?
**Coal itself actually raises another question as well (and I guess this is true of most commodity businesses) because of the regulatory uncertainty surrounding it. Companies have done their best to brand “clean coal” as something that actually exists – there’s a raging ongoing controversy about whether it does. This is just a comment – I don’t think Buffett is trying to make a call based on this, he’ll leave that to the lobbyists and marketing gurus.
The other top-down type consideration is what other ways there may be to monetize the actual land along rail lines – with things such as broadband cables and windmills speculative considerations. Again, I don’t think Buffett is specifically thinking about these considerations – but they exist.
Anyway, those are my long-winded thoughts on the difference between being a top-down and bottom-up investor (aside: do these words need to be hyphenated?). If you have a different take, feel free to leave it in the comments. Thanks for reading.
Disclosure: I currently have long positions in BRK-B and COP. No other positions in any other companies that are discussed.
I consider myself a bottom up investor;)
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