As we explain throughout our web site our research methodology is based on the belief that the companies that consistently create economic value today are those that, most of the time, create lasting shareholder value in the future. This is why our research focuses on understanding and highlighting the strengths and weaknesses in a company’s financial results, strictly based on what many call fundamental analysis. This focus, however, doesn’t mean we don’t understand the important effect supply and demand for a stock have on its price, especially in the short and medium term (one to six months) and particularly in a volatile market like the one we’ve experienced in the last couple of years. Many of these supply and demand factors or indicators can be tracked or measured using technical analysis, while others require a more qualitative approach. At MarketGrader we refer to them as “sentiment” factors since they ultimately measure—and are based—on the sentiment that surrounds any given stock, which influences the amount of buying and selling investors and traders are doing, thus affecting its price. In order to account for this important aspect of stock market behavior we have created our new Top Down Analysis, now available in our new web site. It is comprised of three sub-sections and was designed to complement our traditional fundamental, or bottom up, analysis and give our clients a unique perspective on the factors affecting the stock prices of the companies followed by MarketGrader.
The first part of our Top Down Analysis is our Sector Analysis, which tracks the overall price momentum of all ten sectors followed by MarketGrader. By tracking the historical prices of the stocks in each sector we’re able to assess the group’s overall price trend by placing a bigger emphasis on more recent prices over older ones. Obviously since sectors are the broadest classification categories that we track this price trend should be seen only as a general guideline for the entire group as there will always be significant price variations among the underlying components. Our analysis assigns each sector a Positive, Neutral or Negative signal.
The second part of our Top Down Analysis is our Sub-Industry Analysis, which combines two technical indicators to arrive also at a Positive, Neutral or Negative trend signal. Like the Sector Analysis, the first technical indicator used in this analysis also looks at the historical prices of each of the sub-industry’s components in order to determine the group’s overall momentum. The second component ranks the approximately 150 sub-industries we follow, based on relative strength. The combination of both components determines the overall trend signal.
The last part of our Top Down Analysis is our Sentiment score, which itself is based on four individual indicators. The first indicator, called Price Trend, is similar to the Sector indicator explained above. It uses historical price moving averages to determine if the stock is trading in a positive or negative trend, again emphasizing more recent prices over older ones.
The second indicator, called Price Momentum, is in turn similar to our Sub-Industry indicator as it uses a combination of price momentum and relative price strength, in this case based on the daily ranking of all stocks followed by MarketGrader. Together with the Price Trend indicator it comprises the half of our Sentiment rating that focuses on technical analysis.
Our third Sentiment indicator, called Earnings Guidance, doesn’t actually track the company’s earnings as we already do that in several of our Fundamental Analysis indicators. This indicator tracks the ongoing changes in the investment community’s expectations for the company’s future earnings announcements. It is based on the rate and speed at which analysts change their earnings estimates of future reports. For example, when a company issues new guidance about upcoming earnings reports, in which it lowers or raises what it expects to earn in future periods, the analysts that follow the stock will adjust their models and their estimates accordingly. As the overall consensus view changes it will influence overall investor expectations, affecting the price of the stock. It is this dynamic that our Earnings Guidance indicator attempts to capture, quantify and include in our Sentiment analysis.
The final MarketGrader Sentiment indicator, called Short Interest, tracks the rate and speed at which a percentage of the company’s outstanding share float is sold short. In other words, the indicator tracks how many of the company’s shares available to be transacted in the open market are being used to bet on a future drop in the price of the stock.
Our four Sentiment indicators are individually graded, like our fundamental indicators, from A+ to F. Their four grades are then aggregated into a final numerical score ranging between zero and ten, which in turn determines our Positive, Neutral or Negative Sentiment signal.
Armed with our three new Top Down signals investors will now be able to put the company’s underlying financial health in the context of what the market is saying about the stock in an unbiased and unemotional way. They will also be better able to pick their entry or exit points even if they are planning on investing for the long term. All three Top Down signals have also been incorporated into our Advanced Search, allowing you to use them as filters when looking for stocks that fit your investment needs. You may see a complete Top Down Analysis for free by viewing any of the stocks in our Featured List or Featured Index this month, both available on our home page. Please click on the Top Down link on the small box next to our traffic light box to see it. You may also see all Sector ratings and our current Sub-Industry rank by going to the Price Trend & Momentum page in our Industry Analysis section (subscribers only.)
More on the new MarketGrader in part 3 of our introduction.