**Why are we doing this? **

We believe 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 analyses 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- Some stocks have outdated research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**:

**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 11 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:**10%**Min coefficient (0):**if ROAE is 10% or less**Max coefficient (5):**if ROAE is 25% or more**0 Binary:**If the latest equity is less than 0 or if the 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 the last 3 years. The word “compound” denotes the fact that CAGR takes into account the effects of compounding or reinvestment over time.

**Weight:**10%**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 the latest net Income is less than 0 or if the metric is unavailable

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

**Weight:**5%**Min coefficient (0):**If three 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 the cash conversion cycle is more than 180 days**Max coefficient (5):**If the cash conversion cycle 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 adjust 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 the actual receipt of cash.

**Weight:**5%**Min coefficient (0):**If the 3-year CFO to net income is 30%**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:**5%**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:**20%**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 the target price is not available

**Factor 10 (6M ADTV (EGP M)):** Measures a stock’s liquidity, the higher the traded value of a stock, the more trading activity there is on it & less volatility.

**Weight:**5%**Min coefficient (0):**If the 6M ADTV is 4M or less**Max coefficient (5):**If the 6M ADTV is 12M or more**0 Binary:**If ADTV is not available

**Factor 11 (Dividend Payout Ratio (3Y Avg.))**: The factor shows how much of a company’s profits go to shareholders.

**Weight:**5%**Min coefficient (0):**If the ratio is less than 20%**Max coefficient (5):**If the ratio is 60% or more**0 Binary:**0 if less than 20% or unavailable

Some metrics are not relevant to banks and financial services companies, which means that these stocks might be getting a hit on their overall score.

So we replaced factors 4, 5, & 6, & added two factors specific to banks.

**Factor 12 (Liquidity Ratio)**: The factor is the requirement whereby banks must hold an amount of high-quality liquid assets that’s enough to fund cash outflows

**Weight:**10%**Min coefficient (0):**If the ratio is less than 30%**Max coefficient (5):**If the ratio is 60% or more**0 Binary:**0 if non-banks or if Unavailable

**Factor 13 (Capital Adequacy – Tier 1 Capital %)**: The factor is a measurement of a bank’s available capital expressed as a percentage of a bank’s risk-weighted credit exposures.

**Weight:**10%**Min coefficient (0):**If the ratio is less than 11.5%**Max coefficient (5):**If the ratio is 15% or more**0 Binary:**0 if non-banks or if Unavailable

**News & Stock Liquidity Scans**

Once numbers have been crunched & we have our top 10 stock picks based on the methodology above, we make sure to put these companies through:

**News Scan**– It’s important to make sure all companies’ latest disclosures & news in the press over the past 30 days have no red alerts because as financially strong as a company may be, a single negative piece of news could significantly impact the stock.**Stock Liquidity Scan**– Stocks with low liquidity may be difficult to sell & may cause you to take a bigger loss if you cannot sell the shares when you want to. If a stock’s 6-month average traded value is less than EGP 1 million, we exclude it from the top 10 stock picks.

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 thndrclaps@thndr.app.

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