Bottom fishing is an investment strategy in which investors seek to buy assets that are considered undervalued or have recently dropped in price.
Investors engaged in bottom fishing are known as “bottom fishers”.
If “bottom fishers” buy assets at what is effectively a discounted price, they could profit if the price rises. Note that an asset’s price can turn against your position, which could trigger losses.
Bottom fishing explained
The bottom fishing definition essentially embodies the oldest trading formula: buy low, sell high.
One of the hardest aspects of bottom fishing is knowing how to recognise a low-cost stock that could bring gains. An asset’s price is only a partial description of its “real” value. Identifying undervalued companies with sound principles and financials requires patience and skill.
Bottom fishing does not come without risk. The price of a security may depreciate for fundamental reasons. It could be challenging to determine if a decline is due to a temporary factor or indicates underlying structural problems.
Here are some examples of bottom fishing:
Buying airline stocks during a global pandemic
Buying shares of a bank during a financial crisis
Investing in a pharmaceutical company at the beginning of a disease outbreak
In each one of these examples, it’s unclear as to whether the stock will recover — uncertainty in the markets means that the asset’s price could go either way.
Investors who bought banking stocks during the 2008 financial crisis managed to generate significant returns, while investing in airlines during the Covid-19 pandemic may have produced losses, since many companies failed to recover from the impact of travel restrictions and reduced demand.
Bottom fishing strategies
The most popular bottom fishing strategy is known as value investing. It operates under the assumption that the stock market is inherently inefficient, which results in many assets being overvalued or undervalued and creates investment opportunities.
Value investors look at valuation ratios and project future cash flows to look for opportunities where the market may be incorrectly pricing assets. They believe the market tends to overreact to both positive and negative news, resulting in stock price movements that do not correspond to a company's long-term fundamentals. This asymmetry allows one to earn a profit by purchasing stocks at discounted prices.
The strategy involves carrying out a detailed fundamental analysis of the company and the industry as a whole. The basis for successful value investing lies in a thorough study of the firm's activities.
To determine the real value of a stock, an investor has to examine the company's fundamental factors, such as its business model, brand strength, target market and competitive advantages, as well as its financial performance. Some common metrics used to value a company's stock include the price-to-book (P/B) and price-to-earnings (P/E) ratios as well as free cash flow.
Prominent value investors, such as Warren Buffett and Peter Lynch, have amassed fortunes by following this strategy — they are known for analysing financial statements and valuation multiples to determine where the market has incorrectly priced a stock.
