Introducing MoneyGeek's Stock Ratings

Last update on March 28, 2016.

 

Image credit: Olivier Le Moal / Shutterstock.com

 

A few months ago, I unveiled what I had then called ‘Stock Centre’ as a new feature on this site. Since then, I’ve changed the name of the feature to, simply, ‘Stocks’, and I’ve worked hard to add new enhancements to this feature.

Today, I’m proud to show off the new enhancements. As of right now, the Stocks page has ratings on each and every single stock that trades in Canada. You can see the list of the most highly rated stocks using the ‘Research’ -> ‘Stocks’ menu at the top of this page, or by using this link. Obviously, I didn’t personally analyze each and every Canadian stock, of which there are over two thousand. Rather, I’ve developed an algorithm that assigns the ratings.

When it comes to rating stocks, the rating methodology matters a great deal. Indeed, my site is not the first to have created ratings based on algorithms. However, I was motivated to create these ratings because I wasn’t happy with any of those other sites.

Here’s one example that led me to the conclusion that the other sites’ ratings were inaccurate: these sites claimed that high quality stocks like Google were very overvalued, and thus were likely to underperform. Google’s stock in particular has nearly doubled since I checked those ratings three years ago, proving those ratings wrong. I think the problem is that these other sites are run by tech people who only have skin deep knowledge of investments. Their idea of rating each company was cool, but I was not impressed by their execution.

I believe the ratings on MoneyGeek’s stock pages are better. To assign the ratings, I’ve largely used the methodology outlined in Gray and Carlisle’s book, “Quantitative Value”.

The great thing about Gray and Carlisle’s methodology is that it’s backed by extensive academic research. In their book, the authors use formulas to rate four different aspects of each stock: the chance that the company is exaggerating its earnings, the chance of the company going bankrupt, how cheap the stock is, and how attractive its businesses are. The authors showed the usefulness of each formula by showing how they would have performed historically.

I believe MoneyGeek’s list of most highly rated stocks shows how good this rating system is. I’ve spent some time doing preliminary research into a few of these stocks, and I’ve been pleased with what I’ve found so far. If you’re a fellow value investor like myself, I think you’ll find some stocks on that list worthy of your attention.

That said, the ratings system is not perfect. There are two reasons for this.

First, unfortunately, some of these ratings are based on inaccurate data.

Sometimes the inaccurate data exists because corporate events have occurred and our system just hasn’t received the updated information yet. For example, a company may buy another company, which vastly changes the value and quality of its businesses, but our algorithm may not digest this news fully until months have passed.

But sometimes, the data we use in our ratings methodology is just plain wrong. This could occur, for instance, if the data provider we use gives us inaccurate data due to human mistakes.

The second main reason our ratings system isn’t perfect is that it’s driven by computer algorithms. Even with vast leaps in artificial intelligence, there are some things that only humans can fully appreciate.

Young pharmaceutical companies are a case in point. Many such companies usually have no revenue and spend lots of cash in order to develop new drugs. If a company develops a drug that could cure all types of cancer, that company would justifiably be valued very highly. However, because our ratings system looks only at the company’s past financial record, it would probably rate the company low. It would be extremely tough for computer algorithms to analyze the more intuitive aspects of each stock.

Because of these imperfections, I don’t recommend investing in a stock just because it is rated highly on this site. I believe we should always perform our own in-depth research before we make such decisions.

Instead, I believe the ratings system gives us an excellent starting point from which we can investigate stocks. Put another way, I believe the ratings give us an excellent stock screener.

For those who are new to investing, stock screeners are filters you can use to generate a list of potentially interesting stocks. One such example is the Google stock screener. Using the screener, you can, for example, choose to view only those stocks that are of certain sizes and those that have Price to Earnings (P/E) ratios below a certain threshold.

As those who have used screeners in the past can attest, using stock screeners can be a frustrating experience. Some stocks look cheap according to a ratio like P/E, but turn out to be expensive with a more detailed analysis. Other stocks look cheap but have high debts, making the stock a poor choice for investment. While one can further tweak screeners to give more satisfactory results, such screeners rarely give the user the flexibility they need to properly narrow down the list of interesting stocks.

Furthermore, making use of the screener often takes a lot of know-how. Should we exclude stocks that have a debt to asset ratio of over 3? Should we use a lower threshold instead? For the experienced investor, these are hard questions to answer that often result in trial and error. For the novice investor, these questions may be impossible to answer.

Yet without such screeners, the prospect of researching stocks can be even more daunting. There are over two thousand publicly traded stocks in Canada. Most people don’t have the willingness to investigate all these thousands of stocks. Even if they did try to investigate each one, that would be a hugely inefficient way of researching potential stocks.

This, I believe, is where the ratings system on MoneyGeek’s Stocks page comes in handy. I believe the rating system gives us the best stock screener a computer can give, at least that I know of. I believe the use of our system will save us hours of time spent on stock research.

After researching and ranking each stock, our algorithm ranked a company called Bankers Petroleum as the most highly rated stock among all Canadian stocks. A few days later, news broke that a Chinese company agreed to buy Bankers Petroleum, shooting its stock price up by roughly 60% the next day. For me, that was validation that our stock ratings have some merit.

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