Bottom Fishing

Updated on May 17, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
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 over when other market participants realize the value in the asset during normal market conditions.

Bottom Fishing

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Investors must be cognizant of the risks involved in bottom fishing trading strategy. Investors, at all times, should know what they are getting into 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 to identify stocks without screeners.

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.

Bottom Fishing Explained

Bottom fishing is a strategic investment approach employed by investors seeking undervalued assets, often stocks, with the potential for future appreciation. This method involves identifying securities that have experienced significant price declines and are perceived to be trading at or near their historical lows. The term “bottom fishing” is derived from the idea of metaphorically reaching for stocks at the bottom of their price trajectory, aiming to capitalize on their potential for a rebound.

Investors investing in bottom fishing stocks typically believe that the market has overly discounted the assets, leading to prices that do not accurately reflect their intrinsic value. The decision to engage in bottom fishing requires a careful analysis of the underlying fundamentals of the securities in question, including financial health, industry trends, and potential catalysts for a turnaround.

While this strategy can present lucrative opportunities for investors to buy low and sell high, it also comes with inherent risks. Stocks trading at lower values may have experienced declines due to underlying issues such as poor financial performance, management challenges, or industry headwinds.

Investors employing this strategy must carefully assess and manage these risks, conducting thorough research to differentiate between undervalued opportunities and investments with fundamental challenges.

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.

Therefore, bottom fishing is a contrarian investment strategy that demands a keen understanding of market dynamics and a willingness to assume calculated risks in pursuit of potential rewards.

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Objectives

Let us understand the objectives of investors choosing bottom fishing trading strategy through the discussion below.

#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 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 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

Gauging good stocks or identifying bottom fishing stocks can be done using fundamental analysis and technical analysis. Let us understand how in detail through the explanation below.

#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 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 that can be missed while using only technical or fundamental screeners.

Tips

Even though these are generic tips for utilizing the bottom fishing trading strategy, they can come in more than handy for investors who are just starting out.

  • Conduct comprehensive research on the targeted securities, analyzing financial statements, industry trends, and potential catalysts for a rebound. Understanding the reasons behind the price decline is crucial for informed decision-making.
  • Carefully assess the risks associated with each investment. Distinguish between temporary setbacks and fundamental issues that may hinder a recovery. Consider factors such as market conditions, competition, and company-specific challenges.
  • Avoid concentrating investments in a single stock or sector. Diversification helps spread risk and minimizes the impact of poor-performing assets on the overall portfolio.
  • Adopt a long-term perspective when engaging in bottom fishing. The goal is to capitalize on the potential for future appreciation, and patience is often key to allowing the investment thesis to unfold.
  • Stay informed about broader market trends and economic conditions. A recovery in the overall market can positively influence the performance of undervalued stocks.
  • Manage expectations realistically. Not all undervalued assets will experience a significant turnaround. Be prepared for the possibility that some investments may take time to deliver results or may not recover at all.
  • Seek guidance from financial advisors or investment professionals who can provide valuable insights and assist in making well-informed decisions. Their expertise can be instrumental in navigating the complexities of bottom fishing.

Risks

Identifying and investing in bottom fishing stocks is not free of risks. Let us understand them in detail to ensure we are aware and informed about them while employing our hard-earned money towards such investments.

  • Though bottom fishing can be extremely rewarding, it carries its share of risks, as the beaten-down assets do not always return to their perceived intrinsic value. The assets may also decline in price, damaging the investors’ capital.
  • When the damage to the asset’s price is irreparable, it keeps on declining in price and never returns to the investor’s buying price. In asset classes like stocks and bonds, investments may lose all their value, leaving the investors with damaged merchandise. Such investment decisions might end up risking the total 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 picky about what they will bet on. With years of experience, they develop mental models of the kind of opportunities they can profit from any 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 portfolio’s overall returns. A smart investor understands that some things are valued the way they are due to the right reasons, and he knows them very well.

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.

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This has been a guide to what is Bottom Fishing. Here we explain its objectives, techniques, examples, tips, and risks in detail. You can learn more about financing from the following articles –

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