The Valuentum Buying Index (VBI) stands on the shoulders of giants in finance in uncovering investment ideas. 

Brian Nelson, CFA:

This is Brian Nelson from Valuentum Securities. Today, I would like to talk about our Valuentum Buying Index, the stock selection methodology that we use and apply across our entire coverage universe. But before I get into some of the specifics, I’d like to provide more or less a summary.

Essentially what the Valuentum Buying Index does is it highlights undervalued stocks that are going up in price. Undervalued stocks with good momentum…Value-ntum stocks. So, at the core, the Valuentum Buying Index tries to find stocks that we think have a very strong likelihood of equity price appreciation. It breaks down on a specific basis to three unique pillars. 

The first is a discounted cash-flow based analysis where we’re forecasting the cash flows of a particular company through a three-stage model, forecasting all three of its important financial statements: the income statement, balance sheet, and the resulting cash flow statement to arrive at a fair value estimate. We compare that fair value estimate to the share price to see if a company is undervalued. We obviously prefer companies that are undervalued, but we take that analysis another step forward. The future is always going to be unpredictable, but that doesn’t mean it’s not important. We think there is a number of checks and balances that can be performed to optimize the stock selection process.

That’s why we have another pillar, the second pillar of relative value, so we compare a company versus its peers, its competitors, companies in similar end markets with similar dynamics…on a relative value basis on a P/E basis and price earnings to growth ratio basis…to evaluate whether the company is underpriced in that dynamic. So, the first two pillars are really focused on uncovering those firms that are a bargain, whether or not the market is not capturing the growth potential of the business effectively, whether or not the market is putting too great of a discount on the company’s operations, but for the most part, the first two metrics focus on the qualitative dynamics that drive the valuation equation--and whether or not a company’s underpriced or overpriced.

In the third dynamic, the third pillar of the Valuentum Buying Index, we think is one that allows the process to stand on the shoulders of all the giants in finance in terms of what has been developed over time. Momentum has been shown to exist; it is an embarrassment to the efficient market hypothesis, and we use the concept of pricing momentum, pricing strength as market confirmation of our valuation thesis, of our qualitative assessments.

When all three of the pillars: 1) underpriced on a DCF basis, 2) relatively attractive against a company’s peers, and competitors, and 3) the market is also showing confirmation through pricing strength and momentum that the company is what we would consider to be a very interesting idea for consideration to the newsletter portfolios. We think that the third dynamic, the pricing strength dynamic, increases the likelihood of what we would call price-to fair-value convergence, or where an underpriced stock advances to fair value.

So, we put all those together, it is the Valuentum Buying Index rating--where we rank companies from 1 to 10, where 10 is the highest. We also look at a number of different factors and our qualitative assessments, and the VBI, the Valuentum Buying Index, can be used as an overlay in a dividend growth process, or in conjunction with the Dividend Cushion ratio, which is a measure of a company’s dividend health and dividend safety. 

So, the one thing to remember from all this is that the Valuentum Buying Index, a Valuentum stock, is an underpriced stock and undervalued stock that is going up in price. Thanks for joining me.

Tickerized for firms in the Dow Jones Industrial Average. Please be sure to consult your personal financial advisor if any idea or strategy is right for you. Originally published September 14, 2014.