Fundamental and valuation indicators

Analyst Revisions Bias

Financial Analysts from banks and research houses cover companies and the evolution of their business. In this process, they issue estimates about the EPS and Sales of a company, and often about other measures as well: dividends, cash flow, ebitda etc.

The Analyst Revision Bias measures how many analysts have reviewed their estimates up or down in the last month. A reading of +100% means that all analysts have increased their estimates, a reading of -75% means most analysts have decreased them.

Analyst revisions help gauge consensus and understand whether the research community for this stock actually has predictive power or - as sometimes happens - is more of a contrarian indicator: in some cases, when all analysts are one-sided on the trade, it’s a sign to do the opposite.

Analyst Expected Growth

Financial Analysts from banks and research houses cover companies and the evolution of their business. In this process, they issue estimates about the EPS and Sales of a company for the next 12 months, and these can be compared with the realized metrics for the company for the past 12 months to gauge what kind of growth the analyst community is expecting for the stock.

Analyst Expected Growth helps gauge the views of the analyst community on the growth potential for the stock. This can either have predictive power or - as sometimes happens - be more of a contrarian indicator: in some cases, when all analysts are one-sided on the trade, it’s a sign to do the opposite.

Discounted cash flows, an absolute valuation method, rely on growth expectations to predict future cash flows and hence potential stock prices. Investors can use analyst expected growth as a benchmark for their own growth expectations.

Return Yield

The return an investor can make on an equity position is divided into two sections: capital and dividend gain.

Capital gain encompasses the appreciation in the price of the asset, compared to when it was first bought. The difference between those two values is the capital gained by the investor, after selling. This value can be expressed as a percentage by dividing the difference by the initial cost amount.

Some equities pay investors a dividend: a portion of the profits to thank shareholders for owning the asset. This is not mandatory but facilitates a healthy relationship between the company and its shareholders. If an asset pays a dividend, this is included in the return yield. The dividend yield can be calculated as the annual dividend per share divided by the current share price.

Earnings and EPS

In short, earnings are the profit of a company: revenues minus costs and taxes.

The after-tax net income earned by a company (found on the income statement) is referred to earnings. Analysts frequently refer to this value to understand a company’s financial structure and forecast growth. This value is calculated by subtracting a company’s costs and taxes from its revenue, every quarter or fiscal year.

Earnings per share (EPS) measures a company’s earnings divided by the number of shares outstanding: measuring how much a company earns per share. EPS is a relative valuation metric which can be used to compare performance between similar companies. A company with a higher EPS, compared to a competitor, is said to be of higher value. Analysts predict quarterly EPS for a company and the company’s share price reacts based on if the forecasted EPS value is either met, missed or beat.

Basis Points

Commonly used unit of measurement to track interest rates and changes in other financial percentages. Basis points are frequently expressed as “bps.”

One basis point = 0.01% - it’s 1/100th of 1%

Consequently: 1% = 100 bps

The term comes from the move from one percentage to another or the spread between interest rates. Since small percentage changes can have a larger outcome, the “base” move is a fraction of a percentage change. This measurement is mostly used for interest rates, equity indices and fixed-income securities (bond pricing).

Pop Quiz:

If the price of the S&P 500 index rises by 20 bps, what percentage change has occurred?

  1. 0.2%

  2. 0.02%

  3. 2%

Price/Earnings Ratio

The price/earnings ratio is a major relative valuation method used to compare performance between similar companies or compare periodic performance within a company. This ratio is calculated as the current share price divided by the earnings per share (EPS). Sometimes referred to as the earnings multiple, investors use this ratio to observe the relative value of a company’s shares.

A high P/E could indicate that a company is overvalued or analysts expect high future growth rates. There are 2 types of P/E ratios - forward and trailing P/E. Trailing means that these are real earnings that the company has produced in the last 12m or last fiscal year. Forward refers to the expected earnings per share of a company, based on the mean/median earnings estimated by the analysts that cover the company. The two measures each have their own drawbacks. Trailing earnings are backward looking, and forward earnings are usually just a lagging indicator based on market performance.

Equity Risk Premium

The ERP measures the excess return granted for owning a stock, when compared to a risk-free asset like a government bond.

The ERP is a measure of cross-asset valuation. It tells you if equities are cheap relative to bonds. High means value, low means cheap.

The ERP is a cross-asset valuation measure comparing the return available for equities with that available for bonds. It applies to single stocks and by extension to equity indexes, and works well for most industries with some relevant exceptions.

The ratio is calculated as the ratio between the share price and the earnings per share. The latter can be trailing earnings or forward earnings.

The chart below shows the trailing PE for SPX in the last 40 years.

Remembering that “low = expensive” you can see that during the 80s and 90s, all the way up to the dot.com bubble, the market was expensive if compared to bonds. For context, this was a period of high PE ratios combined with very attractive Treasury yields in the 6-8% range on the 10y bond. Conversely, the picture shifted in favour of Equities in the age of Quantitative Easing. During the period from 2011 onwards, equities have become meaningfully cheaper than bonds.