New Rover Feature - Stock Ratings

This is the seventh in a series of blog posts describing new features we have added to Stock Rover V7. You can reference our blog to catch up on the previous six posts in this series. In this blog post we will be diving into our new Stock Ratings facility.

Stock Ratings

As much as we would like to be able to predict the future, the reality is no can do it accurately, reliably and consistently. The path the future takes often doesn’t follow the map we have created for it. So when we think about predicting the future performance of a company, we can make highly educated guesses, which can be supported by a lot of data, but ultimately they are still guesses. The real world is always infinitely more complex and nuanced than we might like it to be. Educated guesses, which make total sense in their reasoning, can often be very wrong.

It’s not just us. Company management teams and analysts are not immune to the unpredictable nature of the future. And like the rest of us, they don’t possess any special skills of clairvoyance.

And even if management team and analysts were 100% accurate, a second problem for investors is that management and analyst projections are fully priced into the market. What moves stock prices are changes to those estimates, either via company guidance changes or via analysts estimate changes. Such changes are issued suddenly and unpredictably. And when they happen, they are instantly factored into the market and a new price level gets set. All this happens too fast for an individual investor to profit from the future expectations game.

So with this sobering backdrop as reality, we took a different approach with The Stock Rover Ratings facility. Our view is the best predictor of future performance is the actual past performance of a company over the last ten years of its operating history. In this we are supported by two well know sayings; “Actions speak louder than words” and “What’s Past is Prologue”*.

*Full credit to William Shakespeare for the phrase, “What’s Past is Prologue”. even if his meaning and context were very different from the present day use of the term.

Stock Ratings in a Nutshell

Under the banner of “track record is what matters”, we thought looking at what a company has done over a long operating history would be more a useful approach to help find quality companies. And we decided to build our rating system based on that premise.

So how does it work? In a nutshell, for each company, we look at the value, trajectory and volatility of many different key metrics in many different categories. We then rank the performance of those metrics for the company relative to its Industry peer group. From that we generate percentile scores for the company in six specific categories; growth, valuation, efficiency, financial strength, momentum and dividends. With percentiles, the higher the score the better, where 100 is the best and 1 is the worst.

Is this approach foolproof? Definitely not. There can be critical future events not captured by the ratings facility. For example, a merger or acquisition, sudden management changes, the unexpected entrance of major competitors, the announced gain or loss of major contracts etc. all of which can greatly affect a company’s price performance and valuation. However most of the time, for most companies, the past will be a very good indicator of the likely future.

Percentile Rankings

So how do the percentiles work?

We look at metrics in six categories and derive a percentile ranking of a company vs. its industry peers in each of the following areas:

• Growth
• Valuation
• Operating and Capital Efficiency
• Financial Strength
• Dividends
• Momentum

For each category, we select a set of metrics that we believe are critical to determining the performance in that category. And then for each metric, we look at the value, trajectory and the volatility of the metric and grade it against its peers. Each metric is also assigned a weight based on its importance.

Each metric gets a raw score that is then converted to an industry group percentile score. Then an overall category score is computed based on the percentile scores of each of the individual metrics in the category. Not all metrics in a given category are weighted the same when computing the overall category score. Metrics that are considered more important are given a higher weight and less important metrics get a lower weight.

After all six categories are computed, an overall percentile score is computed for each company based on the component category percentile scores.

Diving Deeper

While the exact formulas used to score stocks are proprietary, we can describe in a general way how the scores are computed. Let’s use the growth category for our example.

In the growth category we evaluate the following metrics:

• Revenue Growth
• Operating Income Growth
• Net Income Growth
• EPS Growth
• Revenue Per Employee Growth
• Next Year’s Expected Revenue Growth
• Next Year’s Expected EPS Growth
• Morningstar Grade for Growth
• Intangible Assets as a % of equity growth

For each given metric, there is a specific formula that is used to evaluate the performance of the company vs. its peers. That formula generates a raw score for the metric that is then converted to a percentile vs. industry peers.

For example for Revenue Growth, Operating Income Growth, Net Income Growth and EPS Growth we look at the computed 1 year, 3 year, 5 year and 10 year growths rates. We also look at the slope (trajectory) of the raw growth metric, as well as the volatility of that growth to arrive at an overall raw score, which is then converted to a percentile against peers.

Another example of a slightly different calculation is the revenue per employee metric where we look at the industry group percentile ranking along with the trajectory and variability of revenue per employee over time. Revenue per employee is an example of a metric that has a lower weighting towards the overall growth score vs. for example, EPS growth, which has a higher weighting.

Viewing a Ratings Report

Note Premium Plus users can generate an unlimited number of ratings reports. Premium users can generate ten reports per month. Premium trial users can generate five stock ratings reports as part of their trial.

Generating ratings reports for stocks is easy. You simply select Stock Ratings from the grey selector panel on the left. Then you either enter the company you want in the ticker box or select the dataset you want to work with and then selected and the stock within the data set in the navigation panel that is directly to the right of the grey selector panel. These areas are all circled in the screen shot below. In the example the selected data set is the Dow 30 and the selected stock is Microsoft.

Once a stock is selected, you can select each of the component scores by selecting the associated tab from the category list that runs across the top part of the display and is highlighted in the screenshot below. The screenshot shows the growth category report for Microsoft.

Comparing Ratings

Note the following feature is for Premium Plus users.

The Ratings report gives great detail on the company you are examining in each of the categories that are evaluated. However suppose you want to compare a bunch of companies against each other. We have provided a way to do this. Each of the component rating scores are also available as metrics and that can be used within views in the table.

We have provided a specialized view in the Library for Stock Ratings that can easily be imported as a view into your table. The screenshot below shows what the Library import looks like. Note the Library table listing the views available for import is sorted by last modified date so the Stock Ratings view, which was the last one added to the Library is on the top. This is done by clicking on the ‘Last Modified’ column header twice to get a descending date sort. After you have clicked the checkbox for the Stock Ratings View, clicking on the import button in the lower right will add the view to your table.

Once the view is added to your table, you can use it to compare companies in any dataset you choose. As an example of this, the screenshot below shows the Stock Ratings for the Dow Jones 30.

Screening with Ratings

Note the following feature is for Premium Plus users.

Finally you can screen using the Stock Ratings as part of your screening criteria. You can screen on individual categories such as growth, valuation or momentum as well as on the overall score. We have also provided a number of predefined Stock Ratings screeners that you can import from the library as shown in the screenshot below.

It is also very easy to create your own Stock Rating Screener. The example below shows the creation of a screener with top scores in both the Growth and Valuation categories for stocks in the S&P 500. See our help facility for more on creating screeners.

Summary

The Stock Ratings Facility is a powerful addition to the Stock Rover investment platform. It can help you find and vet those quality long term companies to invest in that we all seek. We suggest you take it out for a spin and see if you want to incorporate Stock Ratings into your investment process.

If you are a Free or Essentials user and would like to trial the facility, just shoot us an email with your account name and let us know.