I constructed my own indicator for easier interpretation of the situation of companies based on fundamental data - I asked AI for a review.

Your FAI (Fundamental Attractiveness Index) seems to be an interesting and unconventional approach to assessing the fundamental attractiveness of a listed company. Let's break it down:

Structure of the index:

1. Components:
   • Price to Earnings (P/E): Shows how much investors are willing to pay for 1 unit of profit.
   • Price to Book Value (P/BV): Indicates the relationship between the market value of the company and its book value.
   • ROE: Measures the efficiency of generating profit based on equity.
2. Formula:
   • The FAI index uses the square product of the P/E and P/BV ratios, inverted in proportion to ROE, indicating an attempt to balance:
     • High ROE: Attractive fundamental of the company.
     • Low P/E and P/BV: Low market valuation relative to profits and book value.
3. Purpose of the index:
   • The final value of FAI favors companies with high efficiency (ROE) and relatively low fundamental valuation (P/E and P/BV). This makes sense, as cheap companies with solid fundamentals are considered potentially undervalued.

Advantages of the index:

1. Integrated approach:
   • Combines three key financial metrics (P/E, P/BV, ROE), which are fundamental in assessing the attractiveness of companies.
2. Based on ROE:
   • ROE is one of the most important measures for fundamental investors, as it reflects the company's ability to effectively manage capital.
3. Efficiency premium:
   • Companies with low valuation but high capital management efficiency are rewarded, making this index useful in searching for "gems."
4. Built-in limitations:
   • By including the condition that the result must equal 0 if any of the components (P/E, P/BV) equals 0, the index avoids the problem of division by 0.

Doubts and potential weaknesses:

1. Non-linear weighting of P/E and P/BV:
   • Raising the P/E ratio to the square can significantly lower FAI for companies with high earnings valuations, which in turn may discriminate against growth companies. It is worth considering whether this square weight is appropriate.
2. Exclusion of risk factors:
   • FAI focuses on fundamentals and valuation but does not take into account factors such as debt, stock price volatility, or sector-specific characteristics. For example, high ROE with high debt can be risky.
3. Lack of comparison to market averages:
   • There is no reference to market medians for P/E, P/BV, and ROE. The index may perform better if calibrated in an industry context.
4. Low value for technology companies:
   • Technology companies that reinvest profits and have low ROE but high growth prospects may be poorly assessed by this index.

Improvement suggestions:

1. Inclusion of debt:
   • You could include, for example, the Debt-to-Equity or Debt/EBITDA ratio to account for the company's financial structure.
2. Adjustment for industries:
   • Average values of P/E, P/BV, and ROE vary significantly by industry. It would be worthwhile to create a version of FAI comparing companies with others in the same industry.
3. Adding a growth factor:
   • Including the PEG Ratio (Price/Earnings to Growth) as an additional component could improve the assessment of companies with high growth potential.
4. Utilizing historical medians:
   • Comparing the current FAI to its historical values for the same company can provide insight into its improvement or deterioration of fundamentals over time.

Summary:

FAI is an interesting index, especially for value investors looking for undervalued companies with solid fundamentals. However, it is important to remember its limitations, especially for growth or highly indebted companies. If FAI is used as one of the elements of a broader analysis, it can be an effective tool in identifying attractive investments.