The Performance Analysis Score (PAS) system was built over many years by Professor Richard Taffler and Doctor Vineet Agarwal.
What is PAS
It is a unique tool for investors looking to exploit market ignorance of underlying corporate financial health when making investment decisions. A key attraction is its ability to plot highly complex financial measures alongside share price charts and thus deliver clear investment conclusions. Moreover, by comparing value to financial risk it not only indicates situations when the stock-market is undervaluing a company’s solidity, but also generates awareness of shares that are best avoided due to their financial risk, or even sold ‘short.’
2018 has already seen a number of major companies endure financial distress (Capita, Countrywide, House of Fraser etc) and, far worse, household names go bankrupt (eg Carillion and Conviviality). In all cases, both the wounded shareholders and subsequent press coverage have screamed the same question: “Why were we not forewarned?”
Interestingly, PAS did forewarn about these situations, as the example charts below demonstrate.
Indeed, the system has indicated rising risk at all 20 bankruptcies of companies fully listed on the LSE since 2010. The Risk Rating for those 20 companies, plus another 32 listed on AIM that suffered the same fate is available by clicking here
How does it work
A company’s share price is strongly inclined to rise or fall over time to meet the company’s financial strength as indicated by the PAS. Companies where the PAS is below the financial strength threshold for a year are rated as ‘at risk’ by PAS.
PAS plots this score against the share price of its analysed companies. Charts with rising share prices and low PAS scores show investments to avoid. Whereas falling share prices and high PAS scores represent a converse opportunity to invest in companies whose financial strength is misunderstood. Aside from clarity, a beauty of this form of analysis is that it is unbiased and dispassionate.
As you can see, the pictures consist of three lines on a graph. Red is the solvency threshold for the company; Green is the financial strength of the company as measured by the Performance Analysis Score, Blue is the related share price.
PAS was warning of Carillion’s perilously stretched finances many years before its precipitous crash. Whereas the acquisitions spree of Conviviality left it unable to pay a large, unexpected tax demand.
By contrast, misplaced pessimism about an entire sector can unfairly tarnish all shares in that sector as being at risk. Take worries about the UK Retail Sector in the last 2 years and Next’s strong recent share performance. Or the PAS view on Premier Foods, whose indebtedness has been the subject of much debate in recent weeks.