What is Bottom Fishing?
Bottom Fishing is the practice of buying an asset when it has seen a significant decline in its market value due to factors that have affected the overall market or the factors that have affected the specific asset, with a view to profit from the asset overtime when other market participants realize the value in the asset during normal market conditions.
Explanation
Asset prices are volatile and fluctuate wildly from time to time. This happens at both positive as well as negative ends. When the sentiment for an asset becomes extremely negative, led by any factor whatsoever, the asset prices decline to unsustainable levels. That is when investors see high value in them and rush to buy those assets. This buying by value investors is called bottom fishing.
It helps investors generate meaningful returns while containing the risks. Buying undervalued assets brings in a good margin of safety, making it a very successful strategy for investors.
Objectives of Bottom Fishing
#1 – Buying Undervalued Assets
It is primarily focused on buying assets when they are lowly valued. Buying them when they are undervalued builds in the requisite margin of safety. Investors achieve one of their most important objectives, which is risk reduction.
#2 – Generating Excess Returns
Excess returns are higher risk-adjusted returns. This is another important objective of bottom fishing. Buying low and selling high generate quick and outsized profits for investors.
Examples
Here are some generic examples of what bottom fishing is termed as:
- An investor is looking to invest in a steel company, whose share prices have dropped due to the company’s temporarily sluggish earnings led by cyclically low steel prices.
- A DVD rental company, which has seen a significant price decline due to declining demand led by the onset of online streaming apps.
- Investing in a banking stock in a recession.
- Buying an electric utility stock when an adverse government regulation has led to a depressed stock price.
- Buying a foreclosed bank property in a housing price crash.
As stated earlier in the article, not all such opportunities will turn out to be profitable investments for an investor. For example, the DVD rental company might never see its past glory as a structural shift that will move all of its customers to online streaming apps, making the business model redundant and the company bankrupt.
Techniques of Bottom Fishing
It can be done using fundamental analysis and technical analysis.
#1 – Fundamental Analysis
Investors determine which asset is trading at a significant discount to its intrinsic value, which could be its earnings, book value, enterprise value, or cash flows. Once the investors find such assets, they forecast their financial metrics for a couple of years in the future and buy them if they are convinced with its future prospects.
The investors can use fundamental screeners to filter stocks that fall in defined parameters and then research them one by one to find the best fit for their portfolios. Not all undervalued stocks end up being in the portfolio, and investors use their discretion to pick stocks that suit their risk profile and return objective.
#2 – Technical Analysis
Investors find assets that are beaten down and look weak on the technical charts. Analysts use technical indicators to filter assets that are in the oversold territory and pick them up to profit from those opportunities in the future. For example, stocks trading below its 200 days moving average (DMA) can be a criterion for an investor to filter the candidates for bottom fishing.
#3 – Techno-Fundamental Approach
Investors can also use a mix of technical and fundamental analysis, also called the techno-fundamental approach, to go about investing in beaten-down assets. In this technique, investors will generally screen their universe of investments using technical criteria and then screen the results using fundamental parameters to further shorten the list before picking their investment candidates. This technique is highly successful and effective as it can toss out some interesting opportunities which can be missed while using only technical or fundamental screeners.
Risks of Bottom Fishing
- Though bottom fishing can be extremely rewarding, it does carry its share of risks as not always the beaten-down assets return to their perceived intrinsic value. The assets may also decline further in price, damaging the investors’ capital.
- When the damage to the price of the asset is irreparable, it keeps on declining in price and never comes back to the investor’s buying price. In some asset classes like stocks and bonds, investments may lose all of their value, leaving the investors with damaged merchandise. Such investment decisions might end up risking the entire returns of the portfolio. Such opportunities are also referred to as value traps in the investment community.
- Smart investors mitigate this risk by being extremely choosy about what they will bet on. With years of experience, they develop mental models on the kind of opportunities they can profit from any kind of opportunities they will be better off avoiding.
- To further their risk management objective, they adequately diversify their investment portfolio, to ensure that a few bad decisions do not impact the overall returns of the portfolio. A smart investor understands that some things are valued the way they are due to the right reasons, and he knows those reasons very well.
Conclusion
Bottom Fishing can make investors quick and big profits, if done right. However, investors must be cognizant of the risks involved in such investing. Investors, at all times, should know what they are getting into because not only such investments may prove to be worthless, but there can also be no easy exit out of such investments. Using screeners can be extremely helpful to filter the candidates for bottom fishing for beginners. Seasoned investors, however, may have spent considerable time investing for them to identify stocks without screeners.
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