Over the last few years, The Applied Finance Group (AFG) has been developing a new quantitative tool that helps clients easily navigate our various Valuation, Momentum, and Quality metrics. The AFG Investment Grade, as we have named it, uses these metrics in a multi-factor model to rank all the companies within our universe of over 20,000 companies. Companies with the best scores receive an A, whereas companies with the worst overall scores receive an F. This grading system allows subscribers of our research to easily identify attractive investment ideas and avoid potential torpedoes. In addition to ranking companies based on Valuation, Momentum, and Quality, our model also applies different weights to each factor based on what is working in the market. Following is a brief description of why we use each of these metrics when calculating the AFG Investment Grade.
Valuation: AFG’s valuation metrics have proven successful at consistently identifying winners and losers in the market over time, and as a result, can add a significant amount of alpha to any investment portfolio.
We tend to agree with James Montier of GMO who stated that, “Valuation is the closest thing to the law of gravity that we have in finance. It is the primary determinant of long-term returns.” Therefore, we recommend using our valuation metrics as the starting point when screening for attractive investment ideas for any quantitative-driven strategy, as they have a consistent track record of benchmark outperformance over a long-term time horizon, regardless of style, sector, size, or country.
Momentum: Despite outperformance characteristics over the long-term, there are periods of time when valuation is not relied upon by investors. Rather, during these periods investors become more concerned with short-term macroeconomic events. In these moments of irrational fear or greed, we have found it relevant to rely on momentum (EM Momentum) to uncover stocks that are set to outperform. Therefore, by utilizing a momentum variable in combination with our valuation metrics, we are able to capitalize on the outperformance capabilities driven by both metrics.
Quality: Avoiding low-quality companies is another major factor within the AFG Investment Grade Model. Our systematic approach to grading Management Quality helps to eliminate companies with management teams that destroy shareholder wealth.
Another factor taken into account within our model is Earnings Quality. Many studies have shown that companies which carry a high amount of accruals on their books experience the most frequent negative earnings surprises. Therefore, the AFG Investment Grade Model eliminates companies with poor Earnings Quality.
Altogether, the AFG Investment Grade utilizes these factors in a model we believe can be extremely effective at identifying attractive investment opportunities, and eliminating low-quality companies.
AFG’s proprietary multi-factor grading model ranks companies based on the following factors:
- Valuation
- EM Change
- EM Momentum
- Price Momentum
- Earnings Quality
- Management Quality
The AFG Investment Grade is an effective tool for both large-cap and small-cap stocks, as well as within growth and value strategies in the US and major markets around the world. The chart below highlights the performance of this model over the last 20 years.
The companies listed below are a sample of companies that earn A and F Investment Grades. This list is a great starting point for investors looking for potential investment ideas (A grade), or to identify companies as a red flag (F grade).
To see more company grades, learn more about our Investment Grade Process or to take a free trial of our research and investment tools, email us at info@ValueExpectations.com.
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