Equity Valuation and Portfolio Management

SOURCES FOR FACTORS

How do we find factors? The sources are widespread with no one source clearly dominating. Employing a variety of sources seems to provide the best opportunity to uncover factors that will be valuable for developing a new model.

There are a number of ways to develop factors based on economic foundations. It may start with thoughtful observation or study of how market participants act. For example, we may ask ourselves how other market participants will evaluate the prospects of the earnings or business of a firm. We may also want to consider what stock characteristics investors will reward in the future. Another common approach is to look for inefficiencies in the way that investors process information. For instance, research may discover that consensus expectations of earnings estimates are biased.

A good source for factors is the various reports released by the management of companies. Many reports contain valuable information and may provide additional context on how management interprets the company results and financial characteristics. For example, quarterly earning reports (10-Qs) may highlight particular financial metrics relevant to the company and the competitive space they are operating within. Other company financial statements and SEC filings, such as the 10-K or 8-K, also provide a source of information to develop factors. It is often useful to look at the financial measures that management emphasize in their comments.

Factors can be found through ...