New Release of Eqax Rating System
We would like to announce the new release of Eqax Rating System.
As part of this release, we have made many upgrades to the scoring system and the website as well. This post will detail the changes as part of this release.
Reason for changes
Change is the only constant in life. Every entity, be it an individual or a company, has to make an active attempt to change for better, else it would automatically change for worse with time.
When Eqax was envisioned, times were bad (or good depending on how one looks at it). Many Stocks were dirt cheap whereas Quality stocks were relatively very expensive. So the system was leaning towards Benjamin Graham’s method of Value Investing. There were a lot of cigar butts available. As time progressed, we realized the need to evolve; to introduce a little bit of Warren Buffett and Charlie Munger into the mix.
Following were our main objectives:
- To make our methodology more comprehensive and long-lasting.
- To reduce the impact of financial jugglery and dressing up of financial statements done by companies.
- To ensure that the system suggests reasonably good number of good stocks even when overall market is fairly priced or even a little over-priced.
- To make the system more immune to sensex movements, market whims and macro environment.
We are glad that we have achieved quite a lot of above objectives. Following are the changes in order to achieve those
Inclusion of Cash Flow Ratings
Cash Flow Statement is a very important financial statement. It also happens to be highly undervalued. Everybody knows about P/E and Market Cap to Sales Ratios. Negligibly few people think about P/CFO and P/FCF Ratios which are at least as important as P/E and M/S.
Why are they so important? Because companies can show profits and sales which don’t really exist. Unfortunately people are conditioned to consider the Net Profit as the final word. It is not. This is because it can be only on paper. Companies can report that they have made a huge profit. They can also pay dividend and taxes on this profit to look genuine.
But what if they have not received real money. We do not know for sure whether that money will ever come or not. Worse, what if there is no real money involved and the profit was reported higher just to fool the investors. In that case, there is a very high possibility that 3 years down the lane, the company will restate the statements and say that they have actually made a really huge Loss over a period of past 3 years because the cash which didn’t come is never going to come. Please note, this can be done without breaking any law or at least without any proof of breaking any law without much difficulty.
Cash Flow Statement deals with the actual money transferred in or out of business thus hurting the ratings of the companies which report profit but don’t have the Cash to prove it while helping the Ratings of companies which report profits and have the Cash to prove it.
For example, Because of the inclusion of P/CFO and P/FCF Ratings, the Price Rating of Infosys has jumped from 44 to 75 whereas it has slumped to 51 from 97 for Ansal Housing and Construction.
We have added as many as 14 Ratings at lowest level (42 if we also include Standalone & Consolidated ratings) pertaining to Cash Flow. We have also added a new Sub-Level Rating called “Cash Flow Rating” which feeds into the calculation of the Eqaxscore. Following are all these ratings and their explanations
CFO Rating – This is pertaining to the quantum of Cash Flow from Operations and feeds into the Size Rating
FCF Rating – Free Cash Flow is sum of Cash Flow from Operations and Cash Flow from Investments. So if a company has CFO as 200 Crores but it has invested Rs 150 Crore out of that, FCF will be 50 Crores. It is as important as CFO since often companies try to have higher CFO figure by showing dummy Cash Flow into Investments. FCF helps in catching this.
Debt/CFO Rating – Just like we see Debt with respect to Profit, Sales, and Book Value, we now do so against CFO too
Debt/FCF Rating – Similar to Debt/CFO Rating but against FCF. Feeds into the Debt Rating
Growth in CFO Rating – Tracks the growth in CFO over a period of 2 years
Growth in FCF Rating – Tracks the growth in FCF over a period of 2 years
P/CFO Rating – Price per share / CFO per share. Feeds into the Price Rating.
P/FCF Rating – Price per share / FCF per share. Feeds into the Price Rating.
CFO/Sales Rating – Compares the CFO against the Sales
CFO/Profit Rating – Compares the CFO against the Profit
CFO/Equity Rating – Compares the CFO against the Equity
FCF/Sales Rating – Compares the FCF against the Sales
FCF/Profit Rating – Compares the FCF against the Profit
FCF/Equity Rating – Compares the FCF against the Equity
These 6 feed into the newly created Cash Flow Rating.
Inclusion of TTM Ratings
We have also introduced 7 Ratings which are calculated on TTM (Trailing Twelve Months) Basis. These Ratings are calculated based on results of last 4 Quarterly Results rather than previously declared Annual Result. This helps us avoiding the companies which reported great results last year but are reporting bad numbers in recent quarters. To some extent, we were trying to achieve this through Expected Ratings till previous release. However it was causing confusion by creating two sets of ratings which could be very different at times. It also led to perfectly valid criticism about us saying “x is a great stock right now but it will be junk soon”. In that case, we really should be calling it junk right now too. We have heeded to this advice of better and more experienced investors. Following are these 7 ratings and their explanations
P/E Ratio (TTM) Rating – Similar to P/E Ratio Rating but for previous 4 quarters. Feeds into Price Rating.
M/S Ratio (TTM) Rating – Similar to M/S Ratio Rating but for previous 4 quarters. Feeds into Price Rating.
Net Profit (TTM) Rating – Similar to Net Sales Rating but for previous 4 quarters. Feeds into Size Rating.
Net Sales (TTM) Rating – Similar to Net Sales Rating but for previous 4 quarters. Feeds into Size Rating.
PAT Margin (TTM) Rating – Similar to PAT Margin Rating but for previous 4 quarters. Feeds into Profitability Rating.
Growth in Profit (TTM) Rating – Compares the Profit in last 4 quarters against previously declared Annual Result. Feeds into the Growth Rating.
Growth in Sales (TTM) Rating – Compares the Sales in last 4 quarters against previously declared Annual Result. Feeds into the Growth Rating.
Changes in Confidence Rating
Till now we were using Dividend Yield as a constituent of Confidence Rating. This was a little wrong. It is really a Valuation measure and not Confidence measure. So now it is feeding into the Price Rating. In its place, we have introduced a Dividend Payout Rating which is feeding into Confidence Rating. Dividend Payout is the percentage of Net profit disbursed as Dividends. Higher it is, more confidence on the company that profits are real.
We have tweaked our algorithms to change the weightages of these ratings while calculating the higher level ratings. So for example, if P/FCF Ratio shows a lot more correlation with future price changes as compared to say P/B Ratio, P/FCF Rating will be given more weightage while calculating Price Rating. Similarly if Cash Flow Rating is more important than Profitability Rating, it will be given more weightage while calculating Eqaxscores. To some extent, this was being done earlier too, but now it is highly precise and dynamic. So if importance of a particular parameter changes in future, its weightage will change too.
Naturally, the newly introduced ratings have been added to our selection criteria along with the dynamic weightages.
One of our objectives was to make our selection criteria more useful when equity as an asset class is not under-priced. This also was very fair and valid feedback from our premium users. For example, till now our Platinum Category was selecting stocks almost only when whole market was extremely down. Like mentioned earlier, it was typical Cigar Butt selection. It gives great returns when market improves which it invariably does but then you just stop getting more opportunities. So it is not really for as long a term as we wanted.
Also instead of four categories, we now have three. The reason for this reduction was that we were finding more selections in current three categories than we were finding in four as part of previous release. We also wanted to ensure that we do not select more than 1% stocks in our last category.
The changes have caused some minor side-effects too.
Our Batch takes a lot longer than before. So now realistically, we can upload the weekly data and new ratings by around Saturday evening instead of Saturday morning. We believe the new ratings and methodology is every bit worth this delay. We can’t buy stocks on Saturday anyways
The other side-effect is pertaining to financial institutions (NBFCs, Banks, Investment companies etc). Their raw material is Cash itself. So the usage of Cash Flow for them is debatable. Such companies often have negative Cash Flows which is very normal during growth phase. On the hand, it may also be signaling a problem just like other companies. In such cases, we have decided to go ahead with using Cash Flow. In a way, we have opted to err on the safer side. We would prefer giving a bad rating to a good company than giving a good rating to a bad company. Having said that, we are trying to fix this issue and hope to find a resolution soon.
Last but not the least, Thank you for all your support and good wishes in our journey so far. A lot of investors, both young and old provided us a lot of feedback which really played a major part in making this release possible.
To our premium members, Thank you so much for your support and confidence in us. As a token of our gratitude, we have extended your premium membership by 20% duration. This holds good for members whose premium membership has expired also.
We look forward to serving the investor community even better. Please feel free to share your thoughts and any feedback you may have. It really helps us a lot in improving the system.
PS: In case, you are having issues with viewing the website, it might be because of old website’s cookies and temp files in your computer. Please clear your browser’s cache, cookies etc and try again. If problem persists even after that, please report it to us by sending us an e-mail (email@example.com) or by filling up the Feedback Form in Contact Us Page or even as a Comment to this post. We will fix it as soon as possible.