How We Are Differentiated from Other Researchers

  1. Gradient’s short ideas are sourced based on bottom-up identification of significant earnings quality issues but also display fundamental headwinds that make those issues likely to persist or worsen. Also carefully considered is valuation to ensure that the identified concerns are not already reflected in the share price. Gradient’s competitors typically either focus exclusively on the accounting issues or they start with a macro or fundamental short thesis and layer in whatever earnings quality aspects they can find (however tenuous they may be).
  2. Gradient’s Earnings Quality Analytics starts with a screening process for short ideas that relies in part on a robust forensic accounting model – the Earnings Quality Rank (EQR). In creating EQR, the company back-tested hundreds of earnings quality-based concepts to identify those that were most predictive of forward returns and packaged those factors into a model that leverages a unique relative ranking engine. EQR has proven to be predictive, whether measured over an extensive back-test period or over the model’s live performance period since October 2013. It appears that Gradient’s competitors typically rely on untested ad hoc screens to identify research candidates – processes that lack the quantitative rigor and validation of EQR.
  3. Gradient can boast a robust and predictive Equity Incentive Analytics model that flags truly anomalous insider trading activity (reflecting either positive or negative sentiment) based on signals such as opportunistic use of 10b5-1 trading plans, unusual use of hedging instruments, the timing and magnitude of option exercise and sale decisions, active insiders with a history of well-timed trades, and the magnitude of changes in beneficial ownership. It appears that none of Gradient’s competitors has a similar model.
  4. Gradient employs a team-based approach to the writing and editing of all publications to ensure the short thesis is sound and actionable and the report is detailed, fully documented, and reader-friendly. The team includes the analyst as the primary author, the director of research and associate director of research to review and critique the thesis and edit the report, and a final editor.
  5. Gradient’s in-depth coverage-initiation alerts are generally 16-24 pages in length and comprise a summary page of bullet points describing the major issues discussed (such as for the benefit of the CIO) followed by detailed analysis, commentary, charts, and table for the client’s analysts and PMs.
  6. Gradient offers cursory bespoke analysis as a complimentary service to subscription clients.
  7. Each member of Gradient’s staff has significant experience and company tenure, and either holds a CFA or CPA credential or is working towards one.
  8. Gradient is based in Phoenix, which results in lower staff turnover versus firms located in larger financial hubs. It also keeps fixed costs and overhead relatively low, allowing for greater flexibility in pricing.
  9. Clients enjoy ready access to Gradient’s analyst team for in-depth discussions on active coverage.
  10. Gradient’s subscriber base is purposely kept relatively small to ensure that there is no market impact on share price when a new report is released. Clients appreciate this as most take a deliberate approach to investigating potential short positions that combines Gradient research with their own in-house due diligence, a process that may take some time to complete.

Gradient’s process for identifying, developing, documenting, and disseminating short ideas:

1. Initial Selection – creating an Initial Thesis Concerns (ITC) document

  • Proprietary screen comprising a variety of financial ratios and earnings quality signals, including the predictive Earnings Quality Rank (EQR), which is a proprietary quantitative model
  • Factor out industry-specific variables to avoid systematic risk; focus on cash flow and working capital
  • Compare the trends in financial ratios, valuation multiples, and current performance versus peer group, sector, and the company’s historical financials

2. Developing the Full Thesis

  • Deep dive on business fundamentals to identify near-term catalysts
  • Search through filings (statements, footnotes, conference call transcripts) for any forensic accounting
    red flags, also considering corporate governance, audit, and insider trading activity
  • Compare and contrast peers’ and industry best-practices and historical performance
  • If possible, discuss with management to better understand the context surrounding the red flags

3. Writing & Disseminating the Report

  • All coverage initiation Alerts present a mix of accounting concerns and fundamental headwinds/catalysts
  • Any thesis that lacks a fundamental catalyst or demonstrated accounting materiality, or if the concerns are limited to insider trading activity, is written as a brief Snapshot
  • All ideas chosen for a either type of report have actionable insights, poor expected performance relative to their peer groups, and trade at elevated valuations that suggest the issues are not already priced in
  • For each Alert, the analyst follows up with a Research Note after every earnings announcement until a discontinuation report is published, due to either underlying issues lessening or becoming fully priced in
  • All reports are published on the website, and an automated email is sent out to all clients simultaneously
  • Clients also can choose to access reports through a desktop workstation, such as Bloomberg or FactSet
  • Clients are welcome to request private discussions with the Gradient analyst on any name under coverage