Another look at how this works
It’s been a good summer break, but it’s time to maybe produce some more blog content for you all. In this one I will dive a little bit into our approach to producing the ranking indicator, because I know it’s a difficult concept for many to get their head around.
First of all, the rank indicator doesn’t try to capture or indicate much about the price direction of any company we analyze. Instead, it’s all about finding relative strength between companies.
So what is relative strength between companies anyway, and how do we gain from it?
Imagine two companies, company A and company B. They are both well established and mature companies, publicly traded on the US stock market. Company A is experiencing good growth and is represented by a solid management team. Company B on the other hand is in a weaker position, with management turmoil and their cash cow isn’t what it once was.
We could say that company A is in a better place with a brighter future outlook than company B.
There are a few methods of determining this. We can get ahold of all forms of fundamental data on both of them and do our due diligence based on this. We would form a personal opinion based on this information and invest accordingly.
When forming this personal opinion it’s also important to incorporate what we think the market overall believes, as we are too small as a single actor to materially impact the price direction of the stock on these companies. We will not via our investments drastically tilt the supply and demand balance of these companies.
So, if our opinion is contrary and remains contrary to what the rest of the market believes about company A and B, we might not end up making a killing. Instead, the opinion we formed from fundamental data might turn out to be incorrect.
This is all part of the risk of investing of course, and there’s nothing wrong with going down this approach. However, it is not how we calculate our rank values.
Instead of analyzing fundamental data directly, we extract and analyze the conclusions made by investors. We indirectly make our conclusion off of how the market reacts to all the various companies we analyze. This is based on a completely automated and mathematical process, using in-house developed statistical models. You could maybe say we outsource our fundamental analysis by looking at how investors conclude on their own, through their market actions.
No matter your approach to determining what a good investment might be, markets go up or down for many reasons. So even if you pick a winner, it doesn’t need to imply that the price of that company goes up of course. But, if you pick winners, you would still expect them to perform better overall. So if prices go up in general, you’d expect your winner pick to go up more. And if prices go down in general, you’d expect your winner pick to go down less than the overall market. This is because all companies have a lot of the same exposures to the economy as everyone else.
This is how you should thing about the rank indicator as well. A higher rank is indicating a better potential, and our forward looking estimates tell what we think this rank will be going forward in time. Keep in mind however, that if a company ranks too high, in the top 10 range (indicated with a fire icon), we’re in the too hot territory, which indicates unreasonable expectations. These are dangerous picks, so we stick to the next 10, indicated with a thumbs up icon, as these still have some runway available.
This is how we select our winners. And while we keep doing that right, we can expect to outperform the market.