Traffic Lights - comparing a stock vs its peers

One of the first things you will notice about a Stockopedia StockReport is that it is highly visual in nature; using colour, charts and graphical indicators to highlight the most important variables for stock selection.

A key component of the page is the extensive use of what we call the TrafficLights™ which come in two formats, horizontal meters and spots.

The horizontal meters show how each important ratio (e.g. PE Ratio) ranks versus its industry group (vs industry) or the market as a whole (vs market).

We take all the P/E ratios in the set, then rank them from last to first in order. We then assign a percentile to each where 100 is best. This information is used to format the Traffic Light’s width and colour which can be interpreted using the following rules of thumb:

• Width - the wider a traffic light, the better the rank is for that metric. The very best ranked stock in an industry will have a filled meter. The very worst will have a very thin meter.
• Colour - green signifies a high ranking signal, red a low ranking signal. We use 5 colours to signify in which quintile (20% band) each stock has been ranked; from green (ranked in the top 20%) through to red (bottom 20%).

At a glance, an investor can judge the relative merits of a stock across different value, growth and momentum criteria by analysing the colour fingerprint of a StockReport.

The spots are individually calibrated to colour from green to red for the indicator in question depending on whether the indicator is favourable or not for the stock.

Interpreting the Traffic Lights

A company with many green traffic lights may be showing the following characteristics: strong growth, low valuation, positive momentum and good internal returns on capital in comparison to their peer group and the market as a whole.

Our traffic light system is meant as a guide to the relative rank of each company's financial ratio in comparison to their sector and market peer group. Academic finance has long illustrated that shares exposed to quality, value and momentum have a tendency to outperform. But it should be remembered that these factors work best in diversified portfolios. Each individual company is subject to stock specific risks that lead to an extremely wide variability of return.

If constructing a portfolio using the Traffic Lights as a guide it is extremely advisable to use enough diversification to reduce stock specific risk, to seek the counsel of a good advisor and do further research before making investment decisions. Just as a high StockRank does not guarantee a stock will outperform, a set of green traffic lights certainly does not either.