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The Perfect Complement To Our Fundamental Analysis

Our Top Down Analysis was designed to measure factors affecting the market's supply and demand for a stock that have nothing to do with the company's underlying fundamentals. Our analysis measures such factors at the sector, industry and stock-specific levels in order to give you a complete picture of every stock's trading environment.

Understanding Market Sentiment and Supply & Demand

As explained in our methodology, MarketGrader.com believes that fundamentally sound companies that consistently create economic value are the ones most likely to create shareholder value in the future, and so our system is designed to help our clients find them. However, we understand that in the short and medium term many factors unrelated to a company’s fundamentals have a significant effect on the price of a stock. It is therefore not unusual to see poorly rated stocks rise—often sharply—as a result of external factors that have nothing to do with the company’s financial performance, generating tremendous excitement for the stock. For example, a company with poor fundamentals may belong in an industry filled with investor euphoria, such as the dot-com stocks of the late 1990’s. While many of these companies with sound and profitable underlying business models went on to fulfill their promise, most of the dot-com stocks didn’t rise because of their fundamentals; they rose with a powerful tide of investor enthusiasm and predictions of a new paradigm in business where fundamentals were relegated to a minor role in a company’s analysis. Other examples include companies that may become the focus of takeover rumors, perhaps even helped in part by depressed stock prices as a result of the companies’ poor financial performance, such as was the case of Sun Microsystems (JAVA) in early 2009, which was acquired by Oracle despite having lost almost $2 billion in the preceding 12 months.

Top-to-Bottom Analysis

There are plenty of examples of poorly graded stocks rising ahead of a product release, or based on speculation about an upcoming FDA approval of a drug or medical treatment (health care stocks, of course,) or expectations of a favorable ruling in an important lawsuit. The same applies to highly graded companies whose stocks also fall as a result of factors unrelated to their financial performance, many times in tandem with their peers or even an entire sector. While all these factors have very significant effects on stock prices the truth is that the variables aren’t quantifiable and can hardly be predicted ahead of time (unless you’re illegally engaged in trading in a stock based on insider information). But all these stocks do have one thing in common linking them as they rise or fall: speculation. We know that speculation drastically alters the dynamics of the supply and demand for a company’s shares. For example, speculation or rumors of a company becoming a takeover target increase the demand for its shares, outstripping supply in the short term, causing the price to rise until equilibrium is found. Fortunately for us, supply and demand variables (or the factors that affect them) are quantifiable and thus subject to our measurement. MarketGrader.com’s Top Down Analysis was designed specifically to measure factors affecting the supply and demand for a stock and its peers and provide our clients with the necessary information to complement our bottom-up or fundamental analysis.

MarketGrader.com’s Top Down Analysis generates three signals that complement each company’s overall grade and rating. However, these signals do not have any incidence in the calculation of our overall grade and rating, which are based solely on our fundamental analysis. Taken together they’re meant to give our clients a clear top-to-bottom view of a stock’s analysis to help their decision-making process.

Sector Rating

The first section of our Top Down Analysis is our Sector rating. MarketGrader.com uses the historical and up-to-date prices of all stocks in each sector to calculate the sector’s price momentum in order to determine the group’s current trend. Just as we would measure the current price trend of any stock using technical analysis in which recent prices carry a bigger weight than older ones in order to ensure the timeliness of the indicator, we do the same with the entire sector. We then convert the result of this indicator into a Positive, Neutral or Negative signal, descriptive of the sector’s price momentum trend. While this is clearly the ‘50,000 foot view,’ it is the beginning of a process to understand factors surrounding a stock that may affect its price yet have nothing to do with the company’s underlying fundamentals. A ‘sector bio,’ which provides you an overview of the number of ‘buys’, ‘holds’ and ‘sells’ in the sector as well as the stocks with the best and worst sentiment indicators complete this part of the analysis.

 

Industry Analysis

The second part of our Top Down Analysis is our Industry Analysis, which works very similarly to our Sector Analysis. By aggregating the historical prices of all stocks in the 150 sub-industries covered by MarketGrader.com we’re able to calculate each group’s price momentum. We then rank all sub-industries based on our own-calculated price momentum score and generate a signal based on a combination of that ranking and the price momentum score itself. The Positive, Neutral or Negative signal assigned to every Industry alerts investors about the market sentiment surrounding every stock’s sub-industry, likely having an effect on the individual stock’s price. While we understand that no two companies in a sub-industry are equal and that in many cases many companies operate in different segments of their industry, many investors and traders are prone to buy and sell companies in the short term based on their association to their peers.

 

Sentiment

The third and final part of our Top Down Analysis is our proprietary Sentiment indicator. Calculated every night following a trading day, our Sentiment indicator is built to help you track some of the most important factors that affect the supply and demand for a company’s shares. The indicator itself is comprised of four separate indicators, each one of them graded on a nine-point letter grade scale, from A+ to F, just like we do for our fundamental indicators. Each letter grade is assigned a numerical value, which is then used to calculate the overall Sentiment score in a 0-10 range. The MarketGrader.com Positive, Neutral or Negative Sentiment signal is based on the final numerical score.

 

1. Price TrendThe first Sentiment indicator, called Price Trend, is similar to our Sector Analysis indicator. It uses technical analysis to determine if the stock is within a positive or negative price trend, through the use of moving averages, emphasizing more recent prices over older ones. The indicator doesn’t predict what the price will be in the future. Instead it tries to measure the dynamic between the forces of supply and demand for the stock to help investors understand if the stock is moving in a positive or negative trend.

2. Price MomentumThe second indicator, called Price Momentum, is similar to our Sub-Industry Analysis indicator. It combines a measure of the stock’s underlying price trend as described above with a relative strength rank of all stocks in the MarketGrader.com system. The indicator grade is based on the combination of both. For example, an investor may find a stock whose price is moving in a positive direction, or positive trend, within a bullish overall market. The stock’s positive trend may not be as strong as that of many other stocks, making its relative rank poor. This indicates that while trending positively, the stock isn’t performing as well as many others or maybe even the market in general. Together with the Price Trend indicator it completes the technical half our Sentiment indicator.

3. Earnings GuidanceOur third Sentiment indicator, called Earnings Guidance, doesn’t actually look at the company’s earnings themselves (we do plenty of that in our fundamental analysis) but rather at the trend in estimates of future earnings announcements. MarketGrader.com provides investors with unique tools to track the impact of each company’s quarterly reports across all its fundamentals. Yet we also understand the importance estimates have in shaping investor sentiment. Consensus analysts’ estimates are not only widely followed by investors but they also reflect guidance issued by the company between quarterly reports. As analysts adjust their estimates based on company guidance and ongoing changes in business conditions for a particular industry or company, investors react accordingly, adding to an improving or deteriorating sentiment surrounding the stock. It is this dynamic that we attempt to capture and reflect in our Earnings Guidance indicator. As business conditions change throughout the quarter or as companies guide investors on upcoming results and the Street adjusts its perception of those results, MarketGrader.com tracks this trend and incorporates it into the overall Sentiment indicator. A positive Earnings Guidance indicator means earnings estimates have improved in the preceding few weeks and a negative indicator means the opposite. The grade itself is determined both by the magnitude of the adjustments as well as their timing.

4. Short InterestThe fourth and final Sentiment indicator, called Short Interest, is probably the one that most closely tracks the actual supply and demand for a company’s shares. Short interest refers to the amount of a company’s shares that are sold short. In a short sale, the seller borrows the shares, typically from a passive institutional investor, and sells them in the open market betting that the stock’s price will fall, allowing him to buy back the shares at a lower price, replay the lender, and keep the difference. Short interest is reported on a monthly basis by the stock exchanges for all companies that have outstanding short interest. The monthly trends in short interest depict a picture of the sentiment surrounding a given stock based on bets it will go down (or up and short positions must be covered). As short interest climbs, it is clear investors are bearish on the stock. However, the flip side of this trend means that since all shares sold short must be repaid, all short sellers will need to become buyers of the stock at some point, once again altering the dynamic of supply and demand as the price adjusts until equilibrium between buyers and sellers is achieved. It is this dynamic and the monthly trend in short interest that our indicator tracks. MarketGrader.com specifically tracks short interest as a percentage of float (the portion of the company’s outstanding shares that trade in the open market) and its month-to-month changes. The indicator grade intends to reflect the positive or negative sentiment surrounding the stock as implied from the short interest trend.

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