Wednesday, 18 September 2013

Stocks, Crowdrating and the Democratization of Ratings

We have always claimed that the process of rating of a business and its state of health should be more transparent, objective and affordable, even by the smallest of companies. With this goal in mind Ontonix has launched the World's first do-it-yourself rating system - Rate-A-Business - which allows any individual to upload the financials of a company and to obtain, in a matter of seconds, a measure of its state of health. The system works, of course, for both publicly listed as well as private companies. Essentially, the tool shifts rating from a duopoly of two huge Credit Rating Agencies to the Internet, the World's central nervous system. Rating becomes, de facto, a commodity. In order to make our global economy healthier, and to reduce the impact of future crises, it is paramount to transform rating from a luxury, to a commodity. Today, it is possible to know one's levels of cholesterol, for example, for just a few dollars. The information is not just reserved for the rich. Similarly, the rating of a business - its state of health, or resilience - is something that every company should know, even the tiniest SME. This is the philosophy that has driven Ontonix to develop Rate-A-Business.

Assetdyne takes things forward even more. The company also provides a real-time rating system. Even though the system developed by Assetdyne focuses on publicly listed companies and portfolios of their stocks, it too introduces a fundamental new element into the process of rating - the so-called crowd-rating. The value of the stock of a company is the result of a complex interplay of millions of traders, analysts, investors, trading robots, etc. Ultimately, it is a reflection of the reputation and perceived value of a particular company and is the result of a democratic process. Clearly, the value of a stock is also driven by market trends, sector analyses, rumors, insider trading and other illicit practice and, evidently, by the Credit Rating Agencies themselves. However, undeniably, it is the millions of traders who ultimately drive the price and dynamics of stocks according to the basic principles of supply and demand. In practice, we're talking of a planet-wide democratic process of crowd-rating - it is the crowd of traders and investors that decides how much you pay for a particular stock.

What Assetdyne does is to use the information on the value and dynamics of the price of stocks to actually compute a rating. The rating that is computed does not reflect the Probability-of-Default (PoD) of a particular company - this the popular "AAA" kind of rating - it reflects the "resilience" of a given stock (hence the company behind it). Resilience is the capacity to resist shocks, a frequent phenomenon in our turbulent economy. Resilience, besides being a very useful measure of the state of health of any kind of system, not just of a corporation, possesses one very important characteristic - its computation is based on the measure of complexity. It so happens that complexity is the hallmark of our economy, of our times. The rating system developed by Assetdyne delivers, therefore, the following additional information:

Stock Complexity - this measures how "chaotic" the evolution of stock is. In other words, we're talking of an advanced measure of volatility. Complexity is measured in bits. The value of complexity of different stocks may clearly be compared.

Stock Resilience - this measures how well the stock price reacts to shocks and extreme events. Values range from 0% to 100%.

As the computation of the complexity and resilience of a stock are based on closing values at the end of each trading day, the corresponding values also change on a daily basis.

An example is illustrated below.

Assetdyne's rating system is applicable also to portfolios of stocks. The example below illustrates a small portfolio of oil&gas companies.

An important aspect of this particular rating technique is that it is not based on the financial reports (Balance Sheets, Income Statements, Cash Flow, etc.) which are of highly subjective nature. But companies construct their balance statements so as to provide a more optimistic picture and therefore conventional PoD-type ratings inevitably influenced. While financial statements and the resulting PoD ratings are subjective (recall the multitude of triple-A-rated companies that have defaulted all of a sudden, triggering the current crisis) to the point that governments have sued Credit Rating Agencies, stocks represent a considerably more objective reflection of the real state of affairs. Most importantly, the information is known to everyone. Of course, markets are not always right and the price may be wrong but the process of converging to a given price is as objective and democratic as things in this world can get. 

One could conclude that the World's stock markets constitute one huge social network which plays a global game called trading. As the game is played, one of its outcomes is the price of stocks. The price may be "wrong", it may be manipulated but it is what it is. It is the result of the mentioned crowd-rating and Assetdyne uses it to provide new important information on complexity and resilience rating of stocks and portfolios. Innovation in finance is possible.