Bottom Fishing

Reviewed byDheeraj Vaidya, CFA, FRM

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, intending to profit from the asset overtime when other market participants realize the value in the asset during normal market conditions.

Key Takeaways

  • Bottom fishing involves purchasing undervalued assets that have experienced significant market value decline, with the expectation of future profits when the market recognizes their worth under normal conditions.
  • Bottom fishing aims to identify undervalued assets and generate excess returns by capitalizing on their potential appreciation.
  • Bottom fishing techniques include fundamental analysis, technical analysis, and the techno-fundamental approach. While it can be profitable, bottom fishing carries risks as not all undervalued assets may regain their original value, potentially leading to capital losses.

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, asset prices decline to unsustainable levels. 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

Investors achieve one of their most important objectives, which is risk reduction. 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.

#2 – Generating Excess Returns

Excess returns are higher risk-adjusted returnsRisk-adjusted ReturnsRisk-adjusted return is a strategy for measuring and analyzing investment returns in which financial, market, credit, and operational risks are evaluated and adjusted so that an individual may decide whether the investment is worthwhile given all of the risks to the capital invested.read more. This is another important objective of bottom fishing. Buying low and selling high generate quick and outsized profits for investors.

Examples

Bottom Fishing

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Source: Bottom Fishing (wallstreetmojo.com)

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 that 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 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 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 valueEnterprise ValueEnterprise value (EV) is the corporate valuation of a company, determined by using market capitalization and total debt.read more, or cash flows. Once the investors find such assets, they forecast their financial metrics for a couple of years and buy them if they are convinced of their prospects.

Investors can use fundamental screeners to filter stocks that fall within 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 in the oversold territory and pick them up to profit from those opportunities in the future. For example, stocks trading below their 200-day 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, called the techno-fundamental approach, to invest 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

Conclusion

Bottom Fishing can make investors quick and make 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 may such investments prove worthless, but there can also be no easy exit from such investments. Using screeners can be extremely helpful in filtering the candidates for bottom fishing for beginners. Seasoned investors, however, may have spent considerable time investing for them to identify stocks without screeners.

Frequently Asked Questions (FAQs)

1. How does bottom fishing differ from other investment strategies?

Bottom fishing differs from other investment strategies in that it focuses on identifying undervalued assets that have experienced significant price declines. It involves buying these assets expecting their value to recover eventually. Unlike other strategies that prioritize growth or income, bottom fishing aims to profit from recognizing the asset’s value under normal market conditions after a period of decline.

2. What are the advantages of bottom fishing?

The advantages of bottom fishing include the potential for substantial returns on investment if the undervalued asset’s value rebounds. It provides opportunities to acquire assets at discounted prices, increasing the potential for long-term capital appreciation.

3. Can bottom fishing be applied to different types of assets, such as stocks, real estate, or commodities?

Yes, bottom fishing can be applied to various types of assets. It is commonly associated with stock market investing, where investors seek undervalued stocks. However, the concept of bottom fishing can also be applied to real estate by purchasing properties with significant price declines or commodities currently out of favor but with long-term potential.

Recommended Articles

This has been a guide to what bottom fishing is and its meaning. Here we discuss the objectives and techniques of bottom fishing along with examples. You can learn more about financing from the following articles –

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