Combining Fundamental Performance and Valuation Metrics to Score Stocks on Your Watchlist - My Approach

When it comes to evaluating stocks, relying solely on fundamental performance or valuation metrics can provide an incomplete picture. A more comprehensive approach involves integrating both aspects to achieve a balanced and informed investment decision. This article will guide you through a method of scoring stocks on your watchlist by considering both fundamental performance and valuation metrics, ensuring you have a holistic view of each company's potential.

Fundamental Performance Metrics

Fundamental performance metrics give insight into a company’s operational efficiency and financial health. Here are some key metrics to consider:

  1. Earnings Per Share (EPS) Growth:

    • Calculate the 12-quarter average EPS growth.
    • Allocate points based on the growth rate, such as:
      • 10 points for >20% growth
      • 5 points for 10-20% growth
      • 2 points for 5-10% growth
      • 0 points for <5% growth

  2. Revenue Growth:

    • Similar to EPS, calculate the 12-quarter average revenue growth.
    • Use a point system based on growth rates.

  3. Profit Margins:

    • Evaluate gross, operating, and net profit margins over the last 12 quarters.
    • Allocate points based on margin improvement and stability.

  4. Return on Equity (ROE):

    • Calculate the average ROE over the past 12 quarters.
    • Higher ROE should earn more points.

  5. Debt to Equity Ratio:

    • Evaluate the company’s leverage.
    • Allocate points inversely, where lower debt ratios earn higher points.

Valuation Metrics

Valuation metrics help determine if a stock is priced reasonably relative to its earnings, assets, and sales. Here are key valuation metrics:

  1. Price to Earnings (P/E) Ratio:

    • Calculate the current P/E ratio and compare it to the watchlist average.
    • Allocate points based on how much lower the company’s P/E ratio is compared to the average, such as:
      • 10 points for significantly lower P/E
      • 5 points for moderately lower P/E
      • 0 points for P/E around the average
      • Negative points for higher P/E

  2. Price to Book (P/B) Ratio:

    • Compare the current P/B ratio to the watchlist average.
    • Allocate points similarly to the P/E ratio.

  3. Price to Sales (P/S) Ratio:

    • Compare the current P/S ratio to the watchlist average.
    • Allocate points based on the relative value.

  4. Free Cash Flow Yield:

    • Calculate free cash flow yield (free cash flow per share divided by share price).
    • Allocate points based on higher free cash flow yields.

Weighing the Metrics

To achieve a balanced view, it’s crucial to combine these fundamental and valuation scores effectively:

  1. Assign Weights to Each Category:

    • Based on their importance to your investment strategy, assign weights to each metric. For example:
      • EPS Growth: 20%
      • Revenue Growth: 20%
      • Profit Margins: 15%
      • ROE: 10%
      • Debt to Equity Ratio: 10%
      • P/E Ratio: 15%
      • P/B Ratio: 5%
      • P/S Ratio: 5%
      • Free Cash Flow Yield: 10%

  2. Calculate the Composite Score:

    • For each stock, calculate the weighted average of all the metric scores to get a composite score.

Implementation in Google Sheets

You can implement this scoring system in Google Sheets using formulas and functions:

  1. Calculate Averages and Ratios:

    • Use the AVERAGE function to calculate 12-quarter averages.
    • Use division and subtraction for ratios and growth calculations.

  2. Assign Points:

    • Use IF and IFS functions to allocate points based on conditions. For example:
Code for Excel or GoogleSheets:
=IFERROR(IFS( PE < WatchlistAveragePE * 0.8, 10, PE < WatchlistAveragePE * 0.9, 8, PE < WatchlistAveragePE, 5, PE > WatchlistAveragePE * 1.2, -5, PE > WatchlistAveragePE * 1.1, -3, PE > WatchlistAveragePE, 0 ), 0)

Then Weight the Scores:

    3. Use weighted averages to combine scores. For example, in Column A of the Tabulation Row on the Data Sheet (Note: I have two Sheets in my Workbook. One has three years of Data for each company (Data) and another has the Watchlist (Watchlist)):

 =IFERROR(SUM( EPS_Score_Cell * 0.2, Revenue_Score_Cell * 0.2, Profit_Margins_Score_Cell * 0.15, ROE_Score_Cell * 0.1, Debt_Equity_Score_Cell * 0.1, PE_Score_Cell * 0.15, PB_Score_Cell * 0.05, PS_Score_Cell * 0.05, Free_Cash_Flow_Yield_Score_Cell * 0.1 ), 0)

  1. Rank the Stocks:
    • Use SORT and RANK functions to rank stocks based on their composite scores. I use a third Sheet called, "SortedWatchlist".
This method ensures you consider both the performance and the valuation of the stocks on your watchlist, giving you a balanced view for making investment decisions. By integrating these metrics, you can more accurately assess the potential of each stock and make more informed investment choices.


at
Labels: , , , , ,