How Not To Get Beaten By BUD

Revising our approach to researching earnings trades.

Adding A New Metric

Recall that we have been looking at eight different metrics for earnings trades:

• LikeFolio’s earnings score based on social data. The higher the number, the more bullish, the lower (more negative) the number, the more bearish.

• Portfolio Armor’s gauge of options market sentiment.

• Chartmill’s Setup rating. On a scale of 0-10, this is a measure of technical consolidation. For bullish trades, we want a high setup rating; for bearish trades, a lower one.

• Zacks Earnings ESP (Expected Surprise Prediction). This is a ratio of the most accurate analyst’s earnings estimate versus the consensus estimate.

• The Piotroski F-Score. A measure of financial strength on a scale from 0-9, with 9 being best.

• Recent insider transactions.

• RSI (Relative Strength Index). A technical measure of whether a stock is overbought or oversold. We’re looking for RSI levels below 70 for bullish trades and above 30 for bearish ones.

• Short Interest.

I decided to add another metric to that mix: Chartmill’s Valuation Rating, which incorporates several valuation ratios and, like its setup rating, is on a scale of 0-10. It seems like a good complement to RSI, in that an oversold stock that is also undervalued might attract value investors, while an oversold stock that is still pricey according to P/E, PEG, Enterprise Value/EBITDA, etc. might have to fall further to attract the interest of the cigar butt crowd.

Quantifying Our Disparate Metrics

So now we have nine different metrics to look at, which we’re gathering from six different sources, and we have dozens of companies reporting per day in some cases (the graphic below just shows the “most anticipated” earnings releases).

How to boil all this info down? Look at each metric for each stock, and assign a value to it based on how bullish or bearish it is. Take the Chartmill Valuation Rating, for example. If a stock gets a 5, we’ll give that a 0 value (neutral). If it gets 6 or higher, we’ll give it a 1 to indicate that the indicator is bullish. If it gets a 4 or lower, we’ll give it a -1. If it gets a 10 or a 0, we can give it a 2 or a -2, respectively. Then we add those numbers up for all the metrics and come up with a composite score.

A Real World Example

Let’s apply this to a company that just reported yesterday, Budweiser and Bud Light parent, AB InBev (BUD 0.00%↑). Here’s how BUD looked on our nine metrics ahead of its earnings release:

1. Social data: -27.

2. PA Options sentiment: Neutral.

3. Setup rating: 6

4. Valuation rating: 5

5. Zacks ESP: -1.45%

6. F-Score: 6

7. Recent insider transaction(s): None in the last 12 months

8. RSI: 40

9. Short interest: 0.42%

And here’s how we would come up with a composite score for it:

So, based on all that, we would have been neutral on BUD and not placed a bullish or bearish bet on it (instead of what we did do, which was place a bearish bet on BUD that’s currently under water).

We will be applying this approach to the trades we place later today.