Investing in shares with Value Line market indices

Master Class: Topical Investments

Market indicescalculated by Value Line, tracks stocks over 1,700 companies in terms of "timing" and safety. Using a model based on the profitability of companies, Value Line predicts which stocks will have the best or worst relative price performance over the next 12 months. Their calculation is based on the principle of investing the same amount of money in different securities. 

It can be seen that with this method of calculation the index is subject to large fluctuations and a peculiar reflection of the ongoing economic processes. For this reason Value Line index is more sensitive to fluctuations in cheap rather than relatively expensive securities. In addition, each stock is assigned a risk rating, which indicates the volatility of stock prices relative to market averages.

So, it will be quite interesting to look at the calculation methodology, for which we will take two indices. The first index is called Value Line Composite (Arithmetic) Index, второй — Value Line Composite (Geometric) Index. For the greatest clarity, let us give the following example, calculating the first of the indices:

So, in order to calculate Value Line Composite (Arithmetic) Index Suppose that on the first day of trading (day 0), stocks A, B, and C had prices:

—         А — 20$
—         В — 30$
—         С – 40$

Now let's complicate the problem a bit, and suppose that on the next day (day 1) there was a 1:2 split of share A and a 1:4 split of share C. The closing prices on that day were respectively:

—         А — 6$
—         В — 21$
—         С — 11$

Let's calculate our index for one more day (day 2). To do this, let's find out the closing prices:

—         А — 7$
—         В — 20$
—         С — 10$

The relative change in the price of each share is calculated in comparison with the previous day (we use a simple arithmetic formula known to us from the school program: I = A2 / A1), at the same time we do not forget that on the first day there was a split of shares A and C, and therefore we need to multiply the price of the first day by the split coefficient:

—         A = (6*2)/20=0,6
—         B = 21/30=0,7
—         C = (11*4)/40=1,1

Then we calculate the arithmetic mean of relative changes (and remember the school program again):

(0,6+0,7+1,1)/3=0,8

And now, finally, let's calculate the index value. As a basis, we take the absolute value of the index on the zero day - 100. Everything is very simple: multiply the arithmetic mean by the absolute value of the index on the previous day, or:

100х0,8=80

Let's repeat the operation for the second day. Calculate the relative value of price changes on the second day:

—         А = 7/6=1,1667
—         B = 20/21=0,9524
—         C = 10/11=0,9091

Find the arithmetic mean of the relative values:

(1,1667+0,9524+0,9091)/3=1,0094 

And calculate the value of Value Line Composite (Arithmetic) Index  on the second day:

80*1,0094=80,752

Value Line Composite (Geometric) Index Calculation Algorithm is similar to arithmetic, but instead of the arithmetic mean, the geometric mean is taken. The geometric mean of relative price changes is calculated by the formula:

(A1 * A2 * ... * An)/n,

Where A1- the relative change in the price of the 1st stock,
A2 — относительное изменение цены 2-ой акции,
An — относительное изменение цены последней акции.

It is believed that this index gives a better idea of investment performance because individual stocks are not outweighed in the index. This methodology poorly reflects the situation on the market as a whole, but it is very useful for dynamic market analysis. speculators.