How We Rate Sectors & Industries
The Risk/Reward Rating of a sector or industry is based on the market-weighted aggregation of our models for the stocks in each sector or industry. New Constructs’ stock ratings are powered by the best fundamental data in the business. This paper compares our analysis on a mega cap company to other major providers. Figure 1 displays the criteria and thresholds that go into the Risk/Reward Rating for each sector & industry. Note that the Risk/Reward Rating for a sector or industry uses the same methodology as our stock ratings, except that the component metrics are market-weighted averages for the stocks in the sector or industry. Then, we rate the sectors and industry based on their market-weighted Overall Risk/Reward ranking:
- Top 10% = Very Attractive Rating
- Next 20% = Attractive Rating
- Next 40% = Neutral Rating
- Next 20% = Unattractive Rating
- Bottom 10% = Very Unattractive Rating
Figure 1: Risk/Reward Rating for Sectors & Industries
Sources: New Constructs, LLC
New Constructs’ ratings on the stocks in each sector are aggregated according our sector classification system. Below is a summary of the criteria that drive the Risk/Reward rating. We assign ratings to every stock under coverage according to what we believe are the 5 most important criteria for assessing the risk versus reward of stocks. Those criteria are divided into two categories: “Business Strength” and “Valuation”.
1) Business Strength: the quality of the economic earnings of the company and the strength of its business model based on its ROIC.
a) Quality of Earnings measures how reported accounting income compares to the economic earnings of the stocks in the sector/industry.
b) Return on Invested Capital (ROIC) measures the aggregate cash on cash returns of all stocks in the sector/industry.
2) Valuation: based on the expectations embedded in stock prices. Investors should buy stocks/industry with low expectations.
a) Free Cash Flow Yield measures the true cash yield of the companies in the sector/industry.
b) Price to Economic Book Value measures the growth expectations embedded in the prices of the stocks in sector/industry.
c) Market-Implied Duration of Growth (Growth Appreciation Period) measures the number of years of future profit growth required to justify the current valuation of the stocks in sector/industry.