How ShareValue Calculates Quality Score
Now that you understand the individual quality metrics, let's see how we combine them into one score.
The Quality Score Formula
Our Quality Score (0-100) evaluates:
Quality Score = Weighted Average of:
• Return on Equity (ROE)
• Profit Margins (Gross, Operating, Net)
• Return on Assets (ROA)
• Earnings Consistency
• Debt Levels (inverse relationship)
The Scoring Process
Step 1: Gather Quality Metrics
For each stock, we collect:
- ROE (Return on Equity)
- ROA (Return on Assets)
- Gross Margin
- Operating Margin
- Net Margin
- Debt-to-Equity Ratio
- Earnings stability measures
Step 2: Compare to Sector Peers
Each metric is ranked within the stock's sector:
Example for ROE:
- Stock's ROE: 22%
- Sector median ROE: 15%
- Stock ranks in top 20% of sector → 80th percentile
Step 3: Weight by Importance
Different metrics get different weights:
| Metric | Weight | Why |
|---|---|---|
| ROE | High | Best overall quality indicator |
| Operating Margin | High | Shows operational efficiency |
| Earnings Consistency | Medium | Stability matters |
| Debt Level | Medium | Affects risk and sustainability |
| ROA | Medium | Asset efficiency |
Step 4: Normalize to 0-100
The final score is scaled:
- 100 = Highest quality in sector
- 50 = Average quality for sector
- 0 = Lowest quality in sector
Key Takeaways
- Quality Score combines multiple profitability and efficiency metrics
- Comparison is within sectors for fair evaluation
- Higher score = higher quality relative to peers
- Consistency and low debt contribute to quality
Interpreting the Quality Score
| Score | Interpretation | What It Suggests |
|---|---|---|
| 80-100 | Exceptional quality | Best-in-class business |
| 60-79 | Above average quality | Strong competitive position |
| 40-59 | Average quality | Typical for the sector |
| 20-39 | Below average quality | Weaker business model |
| 0-19 | Poor quality | Significant concerns |
Quality Score in Action
Example: Comparing Two Tech Companies
| Metric | Company A | Company B | Sector Avg |
|---|---|---|---|
| ROE | 28% | 12% | 18% |
| Operating Margin | 32% | 15% | 22% |
| Net Margin | 24% | 8% | 16% |
| D/E Ratio | 0.3 | 1.2 | 0.6 |
| Earnings Consistency | High | Medium | — |
Quality Scores:
- Company A: 82 (above average on all metrics)
- Company B: 38 (below average on most metrics)
Quality + Valuation = The Sweet Spot
The best opportunities often combine:
- High Quality Score (great business)
- High Valuation Score (cheap price)
This is rare but powerful—a wonderful company at a bargain price.
What Quality Score Doesn't Capture
1. Future Changes
Quality Score reflects current and historical data. It can't predict:
- New competition
- Management changes
- Industry disruption
2. Qualitative Factors
Some quality aspects are hard to quantify:
- Brand strength
- Corporate culture
- Innovation pipeline
- Management integrity
3. Cyclical Effects
Quality metrics can temporarily decline in recessions without reflecting permanent damage.
Using Quality Score Wisely
Do:
- Use as a filter to find quality businesses
- Combine with Valuation Score for complete picture
- Compare similar companies' quality scores
- Track changes over time
Don't:
- Assume high quality = guaranteed success
- Ignore low quality scores on otherwise attractive stocks
- Compare quality across very different sectors
- Rely solely on the score without understanding the business
Quality Score Caveats
- High quality doesn't mean the stock will go up
- Quality can deteriorate (monitor over time)
- Some industries naturally have lower quality metrics
- One-time items can temporarily distort quality metrics
The Quality-Valuation Matrix
| High Quality | Low Quality | |
|---|---|---|
| Cheap | 🟢 Best opportunity | Value trap risk |
| Expensive | 🟡 Pay up for quality? | 🔴 Avoid |
Strategy: Focus on the top-left quadrant—high quality at reasonable prices.
Next up: Quality vs. Price—understanding the tradeoff.