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.
Table of contents
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
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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
- 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 classesAsset ClassesAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples.read more 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 trapsValue TrapsA value trap occurs when the current price of an unworthy stock appears to be undervalued over time based on fundamental valuation parameters such as Price to Earnings, Price to Book Value, and Price to Cash Flow Ratio.read more 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 portfolioInvestment PortfolioPortfolio investments are investments made in a group of assets (equity, debt, mutual funds, derivatives or even bitcoins) instead of a single asset with the objective of earning returns that are proportional to the investor's risk profile.read more, 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.
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)
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.
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.
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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