If You’re Short On Investment Ideas, Try Looking At Things From A New Perspective

If You’re Short On Investment Ideas, Try Looking At Things From A New Perspective
Stéphane Renevier, CFA

about 2 years ago4 mins

  • Coming up with new investment ideas isn’t easy, which is why it might be time to approach your brainstorm from the opposite direction.

  • If you use a bottom-up approach, try switching to a top-down approach: form a high-level view, assess its downstream impact, and work out which assets will benefit the most.

  • Or if you already use this approach, reverse course: zoom straight into what makes a particular company successful by running screens, investigating special events, and investing in what you know.

Coming up with new investment ideas isn’t easy, which is why it might be time to approach your brainstorm from the opposite direction.

If you use a bottom-up approach, try switching to a top-down approach: form a high-level view, assess its downstream impact, and work out which assets will benefit the most.

Or if you already use this approach, reverse course: zoom straight into what makes a particular company successful by running screens, investigating special events, and investing in what you know.

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Investors tend to go one of two ways when picking the next addition to their portfolio: taking a big-picture view (the “top-down approach”), or zooming in on the investment itself (the “bottom-up approach”). But as it gets harder to find value in the markets, you might’ve found that your preferred approach isn’t turning up winners like it used to. So here’s my advice: come at your brainstorm from the opposite direction.

The top-down approach

The top-down approach consists of forming a high-level view, assessing its downstream impact, and gradually working out which assets will benefit the most.

It could be a view on the macro environment – that, say, inflation will remain hotter for longer than the market believes – or on a tactical theme, like the prospect of consumers spending more on goods than services as world economies open up. You might even want to take a position on a structural theme, like the rise of artificial intelligence.

Your goal then is to clarify your view as much as possible, figuring out all its likely – and even its unlikely – consequences. Once you think you have a good idea of how the different asset classes, regions, and assets will be impacted, your job is to identify which ones will benefit the most. Markets generally price obvious outcomes efficiently, so I’d recommend focusing on the second and third-order effects – the not-so-obvious ramifications.

Take climate change: the switch to greener energy sources should benefit the renewable energy sector. That’s a first-order effect. But renewable energy is highly unpredictable, and needs to be stored with huge utility-scale batteries. So if you were to invest in those battery storage facilities, you’d be putting yourself in a position to profit from a second-order effect. And since those facilities are huge consumers of lithium, you could bet on higher lithium prices to benefit from a third-order effect.

Here’s a simple trick: just ask yourself “And then what?” after each consequence, or “What’s the impact in 5 minutes, 5 months, and 5 years from now?” That’ll help you look at markets more deeply than the majority of investors, and it’ll help you generate higher-quality ideas.

The bottom-up approach

The bottom-up approach tries to identify the attributes of a successful opportunity by zooming into each investment. There’s no big-picture thinking at all.

There are four ways you can generate ideas using this approach:

Fundamental Screening

Screening stocks by some desirable criteria will shrink an unmanageable universe of thousands of potential investments down to a small list of promising ideas. And while screening for something specific can work, you tend to get better results if you use a mix of different attributes: think a high return on equity, low price-to-earnings ratio, and accelerating earnings growth. Narrowing your universe even more by excluding stocks that are illiquid, too small, too volatile, or in sectors you don’t fully understand should likewise reduce your chance of picking bad apples.

You can easily create your own screener using tools like Stock Rover. And if you want to do it like the pros do, you could always try this star hedge fund manager’s magic formula (the output of his screen is regularly updated here).

Technical Screening

This is similar to the previous step, but based on technical factors: a market’s price hitting a new high, say, or the relative strength index suggesting the stock is oversold. Other factors like chart analysis, insider buying, changes in analyst ratings, or the share of short-sellers can also provide clues that lead you to new ideas.

Finviz might be the easiest way to easily screen for those criteria, not least because its homepage already automatically does it for you.

Look at special situations

While markets tend to price assets efficiently most of the time, special situations – like a big earnings surprise or a company on the brink of bankruptcy – often create unique windows of opportunity. And not just those kinds of high-profile events either: make sure to monitor things like spinoffs, restructuring, IPOs, and mergers and acquisitions.

There are websites that track specific special events – this one tells you when a company decides to spin off one of its businesses, for example. But the best way to make sure you don’t miss those opportunities is to set up alerts for certain keywords – the ones above are a good place to start – on Google. It’ll let you know when companies make stock price-altering decisions, along with speculation about which bounty hunter is going to be fronting the next Disney+ Star Wars spinoff.

Invest in what you know

One of the most successful investors of all time, Peter Lynch, was proud to admit that many of his best ideas came to him when he was chatting with friends. So if you’ve been singing a product or service’s praises recently, you might already be onto something. Knowing first hand what makes a company or product good will allow you to understand its strengths and weaknesses, as well as quickly assess how it fares versus its competitors.

We all have the ability to identify great ideas this way: start by listing all the areas you’re passionate and knowledgeable about, and regularly write your observations on that product or company. You might even realize you’ve been exposed to dozens of opportunities without noticing it.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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