How the Valuation Score Works
A technical signal to identify if stocks are trading above or below fair value based on price momentum.
What the Valuation Score Measures
The Valuation Score uses technical price analysis to determine if a stock is trading at a discount or premium relative to its recent history. This is based on mean-reversion research showing that stocks trading below their moving averages tend to outperform over the following 12 months.
Price vs SMA200
How far is the current price from the 200-day moving average? Below = potential value.
Price vs SMA50
Short-term confirmation signal. Being below both SMAs is a stronger undervaluation signal.
52-Week Position
Where does the price sit in its 52-week range? Near the low = more undervalued.
Historical Performance (Backtested)
We tested this signal on 12-month forward returns to match how analysts set price targets. Here's what we found out-of-sample (2020-present):
Price vs SMA200 Signal
| Metric | Result |
|---|---|
| Q1 Return (Most Undervalued) | +49.2% |
| Q5 Return (Most Overvalued) | +11.9% |
| Q1-Q5 Spread | +37.2pp |
| Horizon | 12 months |
Combined with Compass Score
| Metric | Result |
|---|---|
| Q1 Return (Best Combined) | +58.1% |
| Q5 Return (Worst Combined) | +13.5% |
| Q1-Q5 Spread | +44.6pp |
| Hit Rate | 86% |
Key Finding: The valuation signal alone has a large spread (+37pp) but low consistency. When combined 50/50 with Compass Score (quality), the hit rate jumps to 86% while maintaining strong returns. This is why we show both scores - quality + valuation together is more powerful than either alone.
How to Use the Valuation Score
70+ Undervalued
Stock is trading below its moving averages. If analysts also have upside, this is alignment - both technical and fundamental signals agree.
40-70 Fair Value
Stock is trading near its moving averages. No strong technical signal either way. Rely more on fundamentals (Compass Score) for these.
<40 Overvalued
Stock is trading above its moving averages. Even if analysts have upside, the technical picture suggests caution.
Using with Analyst Price Targets
The Valuation Score helps you evaluate analyst price targets. Here's how to read the combination:
Analyst upside: 20%+ AND Valuation Score: 70+
Both technical and analyst views agree the stock is undervalued.
Analyst upside: 20%+ BUT Valuation Score: <40
Analysts are bullish but the stock is technically overextended. Be cautious.
Valuation Score: 80+ BUT few analyst coverage
Technically undervalued but under the radar. Do your research.
Analyst downside + Valuation Score: <30
Both technical and analyst views suggest the stock is overvalued.
Important Limitations
- Not a timing tool: Stocks can stay "undervalued" for months before recovering. The 12-month horizon means patience is required.
- Doesn't know why it's down: A stock below its SMA200 might be cheap OR might be falling for good reasons (earnings collapse, fraud, etc.). Always combine with Compass Score.
- Works better for quality stocks: Mean-reversion is strongest when applied to fundamentally sound companies (high Compass Score). Junk stocks that fall may keep falling.
- Market regime matters: In strong bull markets, "overvalued" stocks may keep rising. In bear markets, "undervalued" stocks may keep falling short-term.
Compass Score
Measures company quality using profitability, cash flow, and efficiency metrics. Best used together with Valuation Score.
Learn About Compass Score →Moonshot Score
Identifies high-quality growth companies with significant long-term potential. A selective approach for growth investors.
Learn About Moonshot Score →