STP Algo Trader - The Method

Welcome to the latest issue of STP Algo Trader "The Method"!

Every Saturday, we will break down each of the inputs that go into our proprietary algorithmic trading system - Signal Trader Pro.

Not only do we want to share the inner workings of our system, but we want to educate you on how to become a better investor. Remember, our ultimate goal is to help you MAKE MONEY!In last week's issue, we discussed one of the groups of "points" in our system.

Remember that a "15" point-scoring system powers our platform. The higher the score, the greater the probability that the idea will be a winner. Our historical data shows a significant difference between the highest and lowest-scoring signals.

In that issue, we discussed the importance of growth. We are looking for higher numbers across revenue, cash flow (EBITDA), and earnings (EPS) in the recent past year-over-year.

Within these metrics, we look at the trends over the previous 12 quarters (three years). We want them to be "positive" at least three-quarters or 75% of the time.

Today, we will discuss another of the measurements where we are looking for this positive trend. That measure is METRIC BEATS.

First, let’s start by defining what we mean when we write “METRIC BEATS.”

The "METRICS" are the operating metrics mentioned above – revenue, EBITDA, and EPS.

The “BEATS” are how the company performs against the estimates of the financial analysts who follow the stock and publish their estimates.

For those of you not familiar with how Wall Street works, there is quite a bit to explain with this concept.

The major investment banks and brokerages – places like Goldman Sachs and Merrill Lynch – employ financial analysts to “follow” large stocks.

These analysts engage with the companies and write research reports talking about the company. What they do and how they are doing…

They also try to predict how the company will do in the future.

They take the historical financial metrics – the income statement, balance sheet, cash flow statement, and other metrics – and model how they think the company will perform going forward.

They often work with the company to develop these "estimates" and also do their own work.

Large companies, like Alphabet, Inc. (NASDAQ: GOOG), may have many analysts covering the stock. Here is a snapshot of the Bloomberg page showing the analysts who cover GOOG stock…

There is much information in that screenshot, but you can see that there are a total of 83 analysts covering the stock.

This is likely one of the highest numbers on Wall Street and makes sense as GOOG is one of the biggest companies in the world. Smaller companies will have far fewer analysts.

For Signal Trader Pro, we only included companies with at least six analysts covering the stock. We need enough analysts to have a robust enough data set.

As mentioned above, each of these analysts will have their own financial model to predict how the company will perform across various financial metrics.

The most important number out there is what is called the "consensus estimates." This is where Wall Street takes the analysts' estimates and calculates the average.

In the case of GOOG, this might be 84 datapoints that are then averaged. Sometimes, financial data services like Bloomberg will do some data cleansing where they throw out the highest and lowest numbers.

These numbers, though, become extremely important for the performance of the stock.

In THEORY, these are the numbers that, on average, the company is expected to report. Reporting a higher number is considered a "beat," and missing the number is regarded as a "miss."

Now, we could write a book on the gaming and strategy involved in these numbers. Well-run companies know how to work with analysts to provide realistic guidance on these numbers, but this also puts them in a position to beat the numbers.

The analysts are "in" on this to an extent. There are serious legal repercussions for making untruthful statements, so neither the company nor the analyst can overtly game the system. The reality, though, is that an entire unwritten process happens between Wall Street and the companies.

This is a process that retail investors have never been exposed to, but that we have been dealing with for the last thirty years. This is the value of a service like Signal Trader Pro. We KNOW what is really happening and what works to make money.

In the next issue of STP Algo Trader - "The Method," we will walk you through why "beats" and "misses" matter to the stock and how we use them.

Click here for more information and to sign up for Signal Trader Pro.