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Answered

Misleading "Value" rating on failing companies and value traps

Ventureshadow 9 months ago in Website updated by SA Admin Daniel Hochman 8 months ago 2

I appreciate the ratings you display for Value, Momentum, Price Revisions and so for, but your ratings embody a systematic error regarding Value. Specifically, failing companies and value traps often show an A or A+ for Value. In some extreme cases all the other ratings are F or D, and still Value appears as A or A+. I understand the method by which this occurs so I am writing to suggest that you revise the method to prevent this. Instead of an A or A+ you might show a rating that shows it can not be determined or is too risky or too stressed to value, perhaps a question mark. A simple rule might be that if all the other ratings are F or D, Value can not be rated.  After all, with your ratings you are trying to represent the future, and future Value can not be represented.

Under review

Hello, I really appreciate you reaching out and sharing your thoughts on our Value Factor Grade. Understandably, when the value factor grade is strong, and all the other factor group grades are weak, it is a clear sign that the company faces issues. In fact, our embedded quantitative parameters would prevent a stock from a having Very Bullish or Bullish recommendation in this scenario. With this in mind, many deep value investors seek to target stocks that are extremely cheap. Often, they look to identify the underlying value metrics, as an example, where EV to Earnings multiples are strong and conventional value metrics are weak or not rated. Our factor grades and quant ratings are provided to provide an instant characterization on how the company compares to its relative sector and to help empower investors make informed decisions along the lines of their preferred investment style. Displaying the value grade helps to identify these undervalued securities quickly. Indeed, a simple screen on our Ratings Screener exhibits 58 stocks out of 4000 equities that fall within these characteristics of strong value grades and weak grades across all other factor styles. The Quant recommendations on these securities range from Very Bearish to Neutral at best. Notably, 38 of these stocks exhibit professional Sell-Side analysts’ recommendations of Very Bullish or Bullish. Clearly, these analysts believe the companies possess some type of future quality that will lead to higher stock prices and better financial prospects. Deep value investors often seek to validate a company’s current qualitative business fundamentals, along with unknown or hidden earnings drivers, to determine an estimate of the company’s future value. These investors look beyond the consensus earnings estimates that we employ in our growth factor grade. It is common practice for these investors to perform business segment analysis, meet or speak with management teams, large shareholders, competitors and suppliers to identify why stocks are mispriced and pinpoint the hidden catalysts that will turn around a company’s prospects. In summary, investors hold different perspectives on a stock’s financial metrics, and they use our grades to identify securities that fit their investment style. What may be a value trap by most standards, or not investment worthy, could be viewed by others as an opportunity. I hope this explanation was useful.

Answered

Thanks,

Daniel Hochman

Director of Product, Seeking Alpha