The StockMarks™ quality cubes are inspired by Warren Buffett’s evaluation of his first 25 years as an investor selecting marketable securities. Buffett’s philosophy on stock market investing is based on a simple formula - the purchase at sensible prices of businesses that have good underlying economics and are run by honest and able people.

We don’t think that his fundamental recipe can be translated into a ready-to-use magic formula or number, but it can be tackled through three-dimensional quality cubes comprised of the theory's ingredients – good business, good management and a fair price.

The challenge is to measure and identify these ingredients based only on secondary information of the kind usually available in databases. Here is our approach.

• What is a good business?

There are many views on what it is a good business, but most would agree that a good business should generate good gross margins adequate for the level of risk and leverage undertaken. We periodically review more than 30 variables frequently correlated with good margins ranging from balance sheet and P&L items to shareholders income growth and retain only the top three better placed to position a company in a 3-D chart of business quality. This list currently includes the growth rate of sales per share in the past three years, the elasticity of a company’s sales relative to its competitors and an adjusted measure of the company's average operating margin in the last five years. All theses indicators are normalised and weighted to reflect their relative importance in the Business StockMark (SMB).

• What is good management?

Assessing management it is a bit trickier because many of the various attributes that define management quality are not available in databases (e.g. their honesty) or are difficult to quantify (e.g. greed and pay checks). Moreover, performance should not be confused with management style (i.e. whether a manager is more or less authoritarian). Therefore we opted for ex-post indirect measures of how a company transforms gross margins into earnings per share and we measure good management in the same way we measure a good business. We periodically review more than ten variables ranging from profitability ratios, management efficiency ratios and reputation indicators to identify the three more valued by the market. Currently, we take into account the returns on average assets, earnings per employees and earnings growth rate year over year. All of the indicators are normalized and weighted to reflect their relative importance in the Management StockMark (SMM).

• What is a fair price?

Well managed good businesses are not expected to sell at bargain prices, and indeed a reasonable premium should be expected. According to Buffett  it is better to buy a wonderful company at a fair price than a fair company at a wonderful price. How do we find this fair price? Here, at SADIF, we performed a thorough analysis to identify the most representative factors of a stock's price and we have selected the following key indicators: price to book value, price to earnings per share and price to sales. Some may argue that the reading of these ratios is not always linear and may vary from sector to sector. However, we have developed an algorithm proven to correct for these problems allowing us to standardize and weight each indicator to arrive at a "price attractiveness" rating, the Price StockMark (SMP).

• Why not an overall measure?

These three quality sub-ratings combine to create the Total StockMark (SMT). Our SMT rating is close to, but not an overall measure. It is an indicator of a company's long term quality. An overall measure would need to cover all the important steps in stock picking analysis and therefore StockMarks should be complemented with other ratings. Market momentum and risk should be taken into account according to each investor's risk tolerance. To facilitate comparison with other rating systems that use a letter-based system (see about stock ratings in the SADIF Academy), we combine the Total StockMark and the Price StockMark to generate the Classical StockMark (SMC) rating, which can be converted into a standard letter system.

We believe that our approach is currently the finest and most complete available given the present level of knowledge about listed companies, but don’t just take our word for it, compare us with other rating systems.