MarketGrader’s ratings, which are designed to help investors identify the world’s best compounders of value, are based on our belief that company fundamentals are the primary drivers of long-term shareholder returns. However, we also understand that often the near-term price movements of a stock seem to run independent of the company’s underlying fundamentals and are instead influenced by investor sentiment.
We therefore designed the MarketGrader Sentiment Score as a market signal that can help investors track the relative attractiveness (supply and demand) of a company’s shares on a day-to-day basis. In the near term the MarketGrader Sentiment Score tends to have a much higher correlation to a stock’s price than the fundamentals encapsulated in the quarterly, semi-annual, and annual financial statements of the company.
The MarketGrader Sentiment Score is a real-time indicator that is calculated daily and is designed to complement our GARP (growth-at-a-reasonable-price) analysis, whose objective is to help investors efficiently navigate the short-term price fluctuations in stock prices. The MarketGrader Sentiment Score can be used by short-run (buy/sell) investors to spot money-making opportunities and by long-run (buy and hold) investors to identify ideal entry and exit points when building up a position around a stock or when looking to take profits after a successful run. The Score is designed to have predictive value within a forward-looking rolling window of 30 to 60 days.
How We Calculate It
The MarketGrader Sentiment Score comprises four individual stock-specific indicators: Price Momentum, Price Trend, Relative Strength, and Earnings Guidance. For every stock, each of the four indicators is assigned a letter grade (A+ to F), which is then converted into a numerical value used to compute a score in a range between zero and ten (0 – 10). The calculation of the Sentiment Score is explained in the last section of this document.
The Price Momentum indicator is based on a widely followed methodology used by technical analysts called the ‘Moving Average Convergence/Divergence (MACD)’ study. It measures the speed at which a stock is rising or falling relative to its average price over long periods of time. The shorter the time frame used in calculating the moving averages, the shorter the duration of the signal produced by the analysis; conversely, the longer the time frame used in calculating the moving averages, the longer the signal’s validity, but the weaker its strength. In our case, we compare the daily price change of the stock to its 12-day and 26-day moving averages. The analysis itself is conveyed in a chart that shows the MACD line, the MACD Average, and the Oscillator, which measures the degree to which both lines diverge from each other, as shown below.
Price Momentum (MACD) Sample Chart
Our analysis looks at three key indicators within the MACD study: the position of the MACD line relative to zero (above or below); the position of the MACD line relative to the MACD Average (above or below); and the direction of the Oscillator relative to the zero line. Our Price Momentum indicator grade is then assigned based on these three signals. Simply put, the Price Momentum indicator identifies the amount of momentum behind a stock price’s move in either direction.
The Price Trend indicator is designed to measure both the absolute and relative strength in a stock’s price returns across various time periods. By relative strength, we mean in comparison to the broad equity market (country) in which it trades and in comparison to its peer businesses (sector/industry grouping).
The three key price trends that go into calculating the Price Trend indicator are the stock’s price return in the last 50, 100 and 200 days. These three returns are ranked for each stock both on an absolute return basis and relative to the broad market and sector grouping.
In addition to the three price returns for each stock, we also use risk-adjusted price returns for each stock over the same three periods. The risk-adjusted price returns incorporate a stock’s sensitivity (beta) relative to both the broad equity market where it trades and its sector grouping. The three risk-adjusted returns are also ranked for each stock, both on an absolute return basis and relative to the broad market and sector grouping.
A Price Trend indicator is then calculated based on all the multiple rankings generated for each stock (50, 100, and 200-day price return ranks relative to the broad market and sector grouping and 50, 100 and 200-day risk-adjusted price return ranks relative to the broad market and sector).
Price Trend Indicator Sample Chart
The Relative Strength indicator is based on another widely used technical study called Relative Strength Index, or RSI. While the Price Trend indicator measures the direction of price movements, RSI measures the speed (time) at which a stock is rising or falling. In our calculation of RSI, we also evaluate a stock’s price change in the last 50, 100, and 200 days. Our indicator is based on a combination of the three, giving a greater weight to the short-term periods.
The same rankings that go in the calculation of the Price Trend indicator go into the calculation of the Relative Strength indicator, though what matters most in assigning scores for this indicator is how each of the rankings is changing over the three time periods. The change in the rankings across the three time periods is used to calculate the Relative Strength indicator.
Relative Strength Indicator Sample Chart
Though most versions of relative strength use only the prices of the underlying stock, our version incorporates both the returns and the risk-adjusted returns relative to the broad market and the underlying peer group, i.e., sector.
Since shares of stock represent an ownership in a company and therefore in a company’s future earnings or cash flows, long-run valuations of a company are determined by the company’s future earnings power. MarketGrader evaluates a company’s true earnings power, along with many other fundamental factors, in our 24 fundamental indicators, which are then reflected in our overall grade and our company ‘Buy,’ ‘Hold,’ and ‘Sell’ ratings. However, our research has also shown that in the short-term, changes in investors’ perception about the future direction of companies’ earnings have an outsized effect on short-term prices, irrespective of whether earnings are growing or the magnitude of the growth. As company executives provide guidance about the direction of earnings based on near term trends, analysts who follow these companies adjust their earnings estimates up or down accordingly. Such adjustments tend to influence stock prices in the near term significantly as investors adjust their expectations based on the revised earnings estimates.
Our Earnings Guidance indicator tracks this dynamic by measuring the changes in a company’s consensus earnings estimates in the last three months. More specifically, we look at the company’s fiscal year consensus estimates today and compare them to the consensus from one, two, and three months ago. The degree by which such estimates have changed, up or down, determine our Earnings Guidance indicator. Our analysis is based on estimates for the company’s next fiscal year, unless the fiscal year-end date is within three months of the date of our analysis. In such cases, we look at the changes in the consensus estimate for the following fiscal year.
Earnings Guidance Sample Chart
The MarketGrader Sentiment Score
The MarketGrader Sentiment Score is calculated based on the four indicators described above. Based on the inputs, each of the four indicators are generated as a nine-point letter scale, from A+ to F, daily. We then convert each letter into a numerical value, which is then used to calculate the Sentiment Score on a 0 to 10-point scale. Therefore, a company with an A+ in all four indicators will earn the maximum Sentiment Score of 10, while a company with an F in all four indicators will earn the minimum Sentiment Score of zero. The four sentiment indicators are not equally weighted, which means they don’t all contribute equally to the Sentiment Score. Finally, our Sentiment rating is based on the final Sentiment Score, with all scores of 3.9 or lower receiving a ‘Negative’ rating; all scores between 4 and 6.9 receiving a ‘Neutral’ rating; and scores of 7 or higher receiving a ‘Positive’ rating.
Sentiment Score History Sample Chart
Note: For companies without an analyst consensus estimate, we are unable to calculate the Earnings Guidance indicator. In those cases, we only use the three remaining indicators in the calculation of the MarketGrader Sentiment Score while ensuring that the weight of the missing indicator is allocated proportionally to the relative weights of the three indicators.