A Structured Framework Matters
Investment research sometimes feels complex and overwhelming but it really shouldn't be. Good long term investments are often just a result of getting the basics right. Here at Genuine Impact, we're distilling institutional investment know-how into something accessible and super easy to understand for everyone.
Often, you may find yourself needing help to choose between potential investments or end up making decisions based on emotional reactions. This is mostly due to a lack of insightful information and tools. It's also important to have a consistent and structured framework when you analyze any investment.
Our Stock Ranking is a quantitative research tool, designed to help long term investors discover and analyse stocks efficiently. This is accompanied by our Insights feature which is a qualitative tool, that helps you follow investment news and reports.
The hope is that using these tools will make you more confident, by giving you a better understanding of your investments.
The Stock Ranking System is a simple concept, which starts with three components:
- Quality: buy well-run companies
- Valuation: at a good valuation entry point
- Momentum: when they are doing better than the share price suggests
Quality has 3 sub components:
- Profitability: returns and cash flow generation
- Financial Strength: how strong the balance sheet is
- Capital Allocation: how shareholder friendly the company is
Quality answers these kinds of questions:
Is the company making good and sustainable returns from its products and services?
Does the company have better operating performance than competitors?
Is the balance sheet of a company robust or under stress?
Is the management team making the right decisions in terms of allocating resources and awarding shareholders?
Quality is one of the most important factors, if not the most important, for long term investing. You have to make sure that you are buying the companies that won’t cause you to lose sleep. You trust the management team to make all the right decisions so that the company is always staying ahead of the curve. As a shareholder, you benefit from both share price going up and / or the dividend payments increasing.
Value has 3 subcomponents:
- Income statement e.g. revenue or earnings per share
- Balance sheet e.g shareholder equity value aka book value
- Cash flow statement e.g. operating cash flow or free cash flow
The basic principle of value investing is that you buy a company for the long term, at a good entry point, when you perceive the company to be under-valued. If you hold the investment for the long term, it will reward you through the possibility that it's valuation increases. It's often the case that a good company is really high quality but the valuation is seemingly too high. In this instance, there's a balance between buying good companies and buying them at a good valuation entry point. It is generally believed that a good quality company will trade at a valuation premium to a less good quality peer.
Momentum also has 3 sub-components:
- Revenue: forecast revisions of sell-side analysts
- Earnings: forecast revisions of sell-side analysts
- Sentiment: expressed as the recommendation (buy, sell, hold) changes of sell-side analysts over a period of time
Of the 3 main factors, Momentum is the least applicable to long-term thinking because it measures the changes of analysts' forecasts on a daily basis. However it gives you a good sense of "timing". The classic "value trap" is when a company is trading at an attractive valuation multiple, but it is just "boring" and does not surprise market expectations. That means that you're invested in a company that appears cheap but won't generate a positive return in the future. So Momentum is important to help you decide "is this the best time to invest". Ideally, you want to buy companies that can consistently beat market expectations. So it is worth checking the Momentum ranking history before you decide if the company deserves more of your attention.
At this point it's also very important to highlight what this framework isn't. As you'll have noticed, this is an assessment process that's based on a limited set of data. It's focused solely on analyst ratings, plus the shared characteristics of securities that can be measured, not news or opinions from the team. The aim is to highlight ideas but you should still research the securities further before you decide whether or not to invest. To give you an example of why this is important, a company with 30% Return On Equity may look attractive but that doesn't mean that you should trust its CEO...This framework allows you to quickly discover and compare ideas, it's intended to be used as a sense check before you buy or sell an investment.
Quality, Value and Momentum are our primary 3 factors as a first step to screen investment ideas. However, they don't provide the full picture. That's why our rankings have a collection of other factors to help you build a complete picture of a company.
Click below to read on.