How Selma detects if investments are cheap or expensive aka measuring the over- or undervaluations

Updated 4 years ago by Patrik Schaer

 Nobody can forecast the future of financial markets. That’s why Selma does not rely on forecasts of any human experts. Instead, Selma makes investments based on accurate numeric data and proven models.
In a nutshell: Selma monitors the price of global stock markets and checks if prices are high or low. Once prices are high, Selma sells investments and vice versa. Selma does this to reduce risks (selling things that are getting too expensive), and to generate additional returns (buying things that are currently cheap).

Example: If Swiss company stocks are valued cheap and Japanese companies expensive, Selma would automatically buy more Swiss stocks and reduce Japanese investments until prices are back to normal (see how Selma checks if something is cheap or expensive).

Why does Selma tracks if investments are cheap or expensive

Selma automatically detects whether the investment products in your mix are cheap or expensive for two reasons:

  1. to lower the risk you’re taking

  2. to take opportunities in markets that are currently valued cheap

How often does Selma measure over- and undervaluations:

Selma tracks financial markets daily and automatically makes adjustments if you should increase or reduce your investments in certain parts of your investment mix.

What does Selma measure:

  1. The daily prices of the stock markets

  2. The profits created by companies and how they have been growing in the past

  3. The interest rates that companies currently pay and what interest rates they paid in the past.

How Selma checks if something is cheap or expensive (in detail)

An out of the box example

Imagine you’re buying strawberries at the market.

The usual price for a kilo of 🍓 is CHF 5.00.

When you are shopping for your weekly 🍰  you would include more strawberries when they cost CHF 3.00 and less when they cost CHF 7.00. Eventually if they cost CHF 10.00 you wouldn’t include any strawberries.

In a similar way Selma approaches the stock market 📈

Selma checks the price you need to pay for an investment product.  To know if the prices are any good, Selma sets them in comparison to the profits generated by the companies included. In that way, Selma calculate how much you are paying for every dollar of profit produced.

If the “normal price” is 20x the yearly profits company earns, it is cheap when can buy this company for 10x the annual profits. However when the price is 30x the annual profits it is expensive. As profits in companies can vary quite a lot from year to year because of special effects and how the economy is doing, Selma compares the average profits of the last ten years to the current price of the investment product instead of just using last year profits.

In financial lingo: Selma uses the Shiller Cape Ratio to compare the actual price of a company or a whole stock market to how much profits it produces.

Selma does not evaluate the the price of every single company stock, but rather takes a broader perspective on the entire market. E.g. on the Swiss market, EU Market, US, Market, …

Quite alike, Selma takes a look at company loans (corporate bonds) 💳

To see if company loans are cheap or expensive Selma takes a look at the interest rate a company currently needs to pay for a loan. Selma sets those interest rates in comparison to the interest rate the local government would need to pay (credit spread). Meaning if a Swiss company normally needs to pay 2% more than the state, we would buy less of it when it currently just pays 1% more as it means less of a reward for for taking the additional risk.

As it obviously also plays a role how credit worthy the company is and if it can pay back its debt we would usually measure the credit spread from a lot of companies with the same creditworthiness (rating) together and compare them to what the state pays.

In financial lingo: Selma measures credit spreads to measure the attractivity of company debt investments.  

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