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Subject 11. Momentum Indicators PDF Download
So far we compared the company with some kind of market benchmark or other companies to get an idea about relative valuation characteristics. An alternative source of valuation data may be the historical information about the company itself, such as earnings and share price trends. Valuation indicators based on the company's historical data are called momentum indicators. There is a great variety of these indicators; we discuss three major ones.

Unexpected Earnings

Unexpected Earnings = Actual earnings per share - Expected earnings per share

Analysts use this indicator as a measure of "surprise" in reported earnings, which can be interpreted as positive excessive return, alpha. Unexpected earnings can be expressed either in absolute or in percentage terms. For example, if consensus earnings expectation for Company K are $0.18 per share and the company reports $0.15, it missed expectations by $0.03 or $0.15/$0.18 - 1 = 16.7% (that is, the earnings surprise is -17%). Company K's negative earnings surprise of $0.03 wouldn't be significant if analysts' expectations were very diverse. If only two analysts follow the stock, one of them expects earnings of $0.02 per share and another analyst predicts $0.34 per share, consensus forecast is still $0.18, but it needs to reflect the variability of expectations. For this purpose analysts can use scaled earnings surprise - a ratio of expected earnings to the standard deviation of expectations.

Standardized Unexpected Earnings

Another way to scale earnings surprise is to divide it by the standard deviation of historical earnings surprises for this stock:

Standardized Unexpected Earnings = Unexpected Earnings / Standard deviation of unexpected earnings

If standard deviation in Company K's unexpected earnings is $0.50, and its earnings surprise is $0.18, its standardized unexpected earnings equal $0.18/$0.50=0.36.

Relative Strength

This indicator is very often used in technical analysis or charting techniques. It is ratio of the current market price per share with a relevant market index. Frequently, this indicator is scaled to 1 in the beginning period for ease of interpretation. If the stock outperforms the index, the relative strength indicator will be greater than 1.

An alternative relative strength indicator is a compound rate of return on the stock. In this interpretation, relative strength indicator compares the company's current price to its historical market value.

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