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Goldman Sachs makes adjustments to its method in valuating European stocks

Monday, March 20, 2017 4:41
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Goldman Sachs Group Inc. (NYSE:GS) is making changes to the way it analyses and compares the European investment profiles (IP) it covers.

The bank said in a note to investors today that it will provide updates on the stocks it covers more frequently, moving to a weekly rebalancing from a monthly rebalancing. Goldman said this will lead to a higher turnover in the valuation of companies with up-to-date analysis.

On the back of the adjustment, WPP plc (LON:WPP) moved into Goldman’s top quantile valuation basket on 12 March from the second quantile following a 10% decline in its share price two days earlier. Under the old methodology of monthly rebalancing, WPP would have remained outside the top quantile for all of March.

The group is also streamlining the number of sector categories used in its ranking of stocks. “With this change, the total number of sectors falls from 53 to 25,” Goldman said.

“These adjustments to the methodology increase the ‘freshness’ of data used in constructing our IP scores and, as a result, we see more extreme moves in our IP factors.”

For instance Dutch company ASML Holding has was listed in the top quantile returns basket because it had higher IP returns than other semiconductor stocks. The company has been removed from the basket and replaced by higher tech names, including Aveva and Sage, after Goldman decided to use a broader technology sector definition that includes communications technology, hardware, IT services, semiconductors and software.

Measures used for calculating IP scores..

Goldman calculates IP returns using an average return on equity, return on capital employed, and cash return on the amount invested in each stock. The top quantile includes stocks with the highest 20% returns within their sector. The bottom quantile are stocks with the lowest 20% returns.

Growth is calculated using an average of a company’s sales, underlying earnings (EBITDA) and earnings per share growth.

The valuation of a stock is worked out using an average price-earnings ratio, price-to-book ratio, dividend yield, enterprise value divided by EBITDA, enterprise value divided by free cash flow and enterprise value divided by debt adjusted cash flow.

The integrated score is calculated as an aggregate score based on returns, growth and valuation.

Goldman determines volatility by the standard deviation of daily total returns over a trailing 12-month period.

The balance sheet of a stock is calculated using net debt to EBITDA, while the size of the company is achieved using market capitalisation. 

Story by ProactiveInvestors


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