## Why are we doing this?

We believe that long term investing based on fundamental research is the right thing to do. Yet, we understand that it can be quite overwhelming and time consuming. So we’ve been picking our brains on how we can help our users easily identify companies that are worth researching.

Our initial take on the matter was to aggregate all the analysis done by research firms on a specific stock and showcase the results in a manner that is easy to understand. However, we soon found out that this didn’t paint a full picture and could sometimes be misleading due to the following:

- Some stocks have very limited coverage and accordingly the consensus might not be representative
- Some stocks are not covered by research houses at all
- Some research reports are of poorer quality than others
- Some stocks have outdated research
- Research reports are not easily accessible

We decided to develop our own solution that is based on **factor investing**. Factor investing is an investment approach that chooses securities based on attributes that are associated with higher returns. This solution should lay the groundwork for your investment decisions homework in a scalable manner. Below is our initial scoring methodology and our first set of stock picks.

It is important to note that fundamental factors explain returns over a long investment horizon. Speculative stocks, in contrast, may significantly outperform fundamentally solid stocks in the short term despite the absence of any understandable catalysts, even a good product or service or at the very least expanding market share to start with.

**Summary of Factors used**

**Our Top Picks**

** Our Bottom Picks **

## What is our Methodology?

A 3 component scoring mechanism that consists of the resulting product of a coefficient, a weight and a binary. The results of all factors are then added to calculate an overall score that we use to rank stocks relative to each other.

**Coefficient (C):**A number that is between 0 and 5 and based on how well the company measures in a given factor**Weights (W):**A percentage that is between 0% and 100% based on how important we feel this factor is relative to its peers**Binary (B):**A flag that is 0 or 1 that excludes this factor in the event of a null agent

*Overall Score = C _{1}*B_{1}*W_{1}+ C_{2}*B_{2}*W_{2} + …. + C_{n}*B_{n}*W_{n}*

The methodology was done in collaboration with Hany Genena – CFA, a veteran researcher and instructor at the American University in Cairo. Hany previously worked as the assistant sub governor of the Central Bank in Egypt and served as the head of research for several reputable Investment Banks in Egypt.

## What factors are we looking at?

We’ve identified 9 fundamental factors that we believe provide a holistic view of any given stock.

** Factor 1 (ROAE): **The average return on equity measures the rate of return on equity capital invested in the firm. Intuitively, it reveals the ability of management to generate a rate of return that is higher than the minimum rate of return required by investors – the so-called cost of equity (COE). In Egypt, a rule of thumb COE is around 15-20% so a sustainable ROE above 20% is a major boost to value.

**Weight:**15%**Min coefficient (0):**if ROAE is 5% or less**Max coefficient (5):**if ROAE is 25% or more**0 Binary:**If latest equity is less than 0 or if metric is unavailable

**Factor 2 (3 Year Net Income CAGR):** Net income CAGR (Compounded Annual Growth Rate), a metric that measures the average annual growth in profits over that last 3 years. The word “compound” denotes the fact that CAGR takes into account the effects of compounding, or reinvestment over time.

**Weight:**15%**Min coefficient (0):**if 3Y Net Income is 0% or less**Max coefficient (5):**if 3Y Net Income is 25% or more**0 Binary:**If latest net Income is less than 0 or if metric is unavailable

**Factor 3 (Last 8 Quarters Losses):** A metric that illustrates a companies tendency to incur losses by counting the number of net income losses during the past 8 quarters.

**Weight:**5%**Min coefficient (0):**If 3 or more losses have occurred during the last 8 quarters**Max coefficient (5):**If no losses have occurred during the last 8 quarters**0 Binary:**If quarter information is not available

**Factor 4 (Net Debt / Equity):** This is known as the leverage ratio. Debt is not always bad. If it is used to fund a high ROE project, then it may be a cheap source of funds particularly given the fact that interest expense is tax-deductible. Yet, if the debt is a reflection of persistently negative operating cash flow, then the firm may be relying on a lifeline to remain alive and this may increase the risk of financial distress. Typically, a ratio that ranges from 1-2x equity is acceptable. Higher ratios – without a strong justification – should make you alert.

**Weight:**10%**Min coefficient (0):**If Net Debt / Equity is 2.0x or more**Max coefficient (5):**If Net Debt / Equity is 0.5x or less**0 Binary:**If equity is less than 0 or unavailable

**Factor 5 (Cash conversion cycle):** ِA measure that shows how many days it takes for a company to convert its inventories into cash flows from sales. Companies that have smaller cycles, can generate cash flows faster than other companies.

**Weight:**5%**Min coefficient (0):**If cash conversion cycles is more than 180 days**Max coefficient (5):**If cash conversion cycles is less than 60 days**0 Binary:**If the value is not available

**Factor 6 (3-year CFO to net income):** Cash flows from operating activities adjusts the net income – which is based on accrual accounting – to a figure that reflects the actual inflow or outflow of cash. The closer the ratio is to 1, the lower the probability that shareholders are bluffed by paper-earnings that do not reflect actual receipt of cash.

**Weight:**5%**Min coefficient (0):**If the 3-year CFO to net income is 0%**Max coefficient (5):**If the 3-year CFO to net income is 100% or more**0 Binary:**If the operating cash flow or net income is less than 0

**Factor 7 (FCFE yield): ** The free cash flow yield is used to help assess the attractiveness of a company from a solvency point of view. We calculated it by using the company’s cash flow from operations less CAPEX less principal repayment plus borrowings to market cap.

**Weight:**10%**Min coefficient (0):**If FCFE yield is 0% or less**Max coefficient (5):**If FCFE yield is 25% or more**0 Binary:**If the operating cash flow or net income is less than 0

**Factor 8 (PEG Ratio): **The price/earnings to growth ratio (PEG ratio) is the price-to-earnings (P/E) ratio of the company divided by the growth rate of its earnings during the past 3 years. The PEG ratio adjusts the traditional P/E ratio by taking into account the growth rate in earnings. Due to the lack of coverage on Egyptian stocks, we used historical growth rates.

**Weight:**15%**Min coefficient (0):**If the PEG ratio is 1 or more**Max coefficient (5):**If the PEG ratio is 0.25 or less**0 Binary:**If PEG Ratio is unavailable or if Net Income is less than 0

**Factor 9 (Analyst Upside Potential):** Expected change in stock prices based on primary analysis done by licensed research houses.. We only account for recent target prices of the top research analysts only to ensure relevancy.

**Weight:**20%**Min coefficient (0):**If the potential upside is 0% or less**Max coefficient (5):**If the potential upside is 30% or more**0 Binary:**If less than 3 analysts cover the stock and no quality house or if target price is not available

## Limitations & Next Steps

Since this is our first time rolling out this initiative, we expect to continuously iterate our algorithm to mitigate current and future limitations. At the very least we expect to address the following limitations:

- Some metrics are not relevant to banks and financial services companies (eg. Net Debt / Equity) which means that these stocks might be getting a hit on their overall score.
- The min and max coefficients are inputted based on our views for the Egyptian market and as such, might not be relevant to foreign markets.
- Our analysis looks at company financials (which are updated every quarter) and views of research analysts (which are updated every month at best) while not accounting for relevant news, sentiment and macro events, which would allow us to update the score in a more frequent manner.

Going forward we expect to update our analysis every month and incorporate the scoring into our platform for easier visibility.

We’d love to get your feedback. Share with us your thoughts and any ideas that could help us improve our methodology and factors used by sending an email to **future@thndr.app**.

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