101 Concepts for the Level I Exam
Essential Concept 46: Top-down and Bottom-up Approaches
Top-down approach begins at the economy level, then the industry and finally to the company level. There are two top-down approaches:
Growth relative to GDP growth: In this approach, we:
- Forecast nominal GDP growth rate (can forecast real GDP growth and inflation separately)
- Forecast revenue growth relative to GDP depending on the company’s position in the lifecycle and/or business cycle sensitivity. The forecasted revenue is expressed in two ways:
- As percentage point discounts or premiums. For instance, Pfizer’s revenue is projected to grow at 100 bps above nominal GDP growth rate.
- In relative terms: GDP is forecasted to grow at 4% and Oracle’s revenue is forecasted to grow at a 25% faster rate.
Market growth and market share: In this approach, we:
- Forecast growth rate of relevant market
- Forecast change of company’s market share in the market. For example, assume Tesla is expected to maintain a market share of 1% in the automobile market. If the automobile market is expected to grow to $30 billion in annual revenue, then Tesla’s annual revenue is forecasted to grow to 1% * $30 billion = $300 million.
Bottom-up approaches begin at the level of the individual company or unit within the company. Examples of bottom-up approaches include:
- Time-series: Forecasts based on historical growth rates or time-series analysis.
- Return on capital: Forecasts based on balance sheet accounts and rates or ratios.
- Capacity-based measure: Forecasts (for example, in retailing) based on same-store sales growth and sales related to new stores.
A hybrid approach combines top-down and bottom-up approaches.