Composite Score & Tracks

Introduction

Different investment theses require different evidence. A compounding business -- like a dominant retailer with decades of reinvestment runway -- needs proof of durable competitive advantage, disciplined capital allocation, and a reasonable price. A mispriced stock -- like a beaten-down cyclical trading below liquidation value -- needs proof of undervaluation, a margin of safety, and a catalyst to close the gap.

These are fundamentally different ways to make money in equities, and evaluating them with a single scorecard would blur the distinctions that matter most. The dual-track system evaluates both theses independently, for every stock, every time.

The Dual-Track System

Investors find returns in fundamentally different ways. Some buy great businesses and hold them for years, letting compounding do the work. Others buy cheap assets and wait for the market to correct its mistake. Both approaches have produced strong long-term returns when applied with discipline.

The engine does not force you to choose. It runs two independent evaluations in parallel:

• Track A: Compounder -- Identifies companies that compound shareholder wealth over time through operational excellence, reinvestment at high returns, and disciplined capital allocation.
• Track B: Mispricing -- Identifies stocks trading at a meaningful discount to intrinsic value with downside protection and a near-term catalyst for re-rating.

A stock can qualify on both tracks (rare and the strongest signal), one track, or neither. The two tracks are not mutually exclusive -- a high-quality business can also be temporarily undervalued -- but the combination is uncommon because the market tends to price quality businesses at a premium.

Track A -- Compounder

Track A uses four gates, each scored on a 0-100 percentile scale. All four must show strength because the gates are multiplied together -- one weak gate kills the entire track score.

Gate 1: Moat Evidence

Is there a durable competitive advantage?

A moat is the structural characteristic that lets a business earn excess returns without those returns being competed away. The engine scans for four moat signatures: scale economics (declining unit costs with volume), pricing power (ability to raise prices without proportional customer loss), switching costs (friction that discourages customers from leaving), and capital efficiency (high returns on invested capital relative to the asset base).

The gate requires at least two distinct moat signatures. A single advantage can be eroded; multiple overlapping advantages are much harder to dislodge.

Gate 2: Reinvestment Engine

Can the company reinvest at high returns?

A moat alone is not enough. The company must also have the opportunity and willingness to reinvest capital at attractive rates. The combination of high returns on incremental capital and a high reinvestment rate is what drives compounding -- earning strong returns on a growing capital base.

• Incremental ROIC measures the return on each new dollar invested, not the average return on all capital. A company with a legacy business earning 30% ROIC that invests new capital at 8% has a high average ROIC but low incremental ROIC.
• Reinvestment Rate is the fraction of earnings plowed back into the business. Higher reinvestment at high ROIC means faster compounding.
• ROIC CV (coefficient of variation) penalizes volatile returns. The term (1 - ROIC CV) rewards consistency -- a company that earns 15% every year is more valuable than one that alternates between 5% and 25%.

Gate 3: Capital Allocation

Is management allocating capital well?

The best business in the world can be destroyed by poor capital allocation -- overpaying for acquisitions, levering up at the wrong time, or diluting shareholders through excessive stock-based compensation. This gate evaluates six dimensions of management stewardship:

• Debt discipline -- Is leverage managed prudently relative to earnings power?
• Organic reinvestment -- Does the company prioritize internal growth over financial engineering?
• Buyback effectiveness -- When shares are repurchased, is it at prices below intrinsic value?
• Insider ownership -- Do executives have meaningful personal wealth tied to the stock?
• SBC dilution -- How much shareholder value is eroded by stock-based compensation?
• M&A discipline -- Has the company's acquisition history created or destroyed value?

Each sub-factor is normalized to a 0-to-1 scale, then combined via weighted average into a single composite.

Gate 4: Valuation / Growth Gap

Even the best compounder can be overpriced.

This gate uses a Reverse DCF approach: instead of projecting cash flows forward to estimate intrinsic value, it works backward from the current stock price to determine what growth rate the market is implicitly expecting. That implied growth rate is compared to the company's demonstrated growth trajectory.

A positive growth gap means the market is pricing in less growth than the company has historically delivered. This provides a margin of safety on growth assumptions -- you are paying for less growth than the company has shown it can produce.

Track B -- Mispricing

Track B identifies stocks where the market price has temporarily disconnected from intrinsic value. It uses the same four-gate multiplicative structure as Track A -- all four gates must show strength.

Gate 1: Ensemble Valuation

Is the stock genuinely cheap by multiple measures?

Relying on a single valuation model is dangerous -- every model has blind spots. The engine aggregates four independent valuation methods to reduce the risk of acting on one model's error:

• Discounted Cash Flow (DCF) -- Projects future free cash flows and discounts to present value.
• Owner Earnings Intrinsic Value -- Uses Buffett-style owner earnings (net income plus depreciation minus maintenance capex).
• Asset Floor Intrinsic Value -- Calculates a liquidation-based floor from tangible assets.
• Peer Comparison Intrinsic Value -- Benchmarks valuation multiples against sector peers.

Beyond the individual estimates, the engine checks for convergence: at least three of the four methods must agree within plus or minus 30% of the median estimate. This prevents the engine from acting on a single outlier model.

Gate 2: Downside Protection

How much could you lose?

Cheap stocks can get cheaper. This gate checks whether there is a meaningful floor beneath the current price by comparing the stock price to the asset floor per share -- an estimate of what the business would be worth in liquidation.

The gate requires at least a 50% cushion to the asset floor. This means that even in a worst-case liquidation scenario, the expected loss is limited. Downside protection is what separates a disciplined value investment from speculative bottom-fishing.

Gate 3: Catalyst

What will unlock the value?

A cheap stock without a catalyst can stay cheap indefinitely -- the classic "value trap." This gate checks for near-term evidence that the market will close the valuation gap. The engine evaluates three potential catalyst signals and uses the strongest:

• Insider Buying Percentile -- Are company insiders purchasing shares in the open market? Insider buying is one of the strongest signals of management confidence, particularly cluster buying (multiple insiders buying within a short window).
• Institutional Accumulation Percentile -- Are institutional investors increasing their positions? When sophisticated allocators start accumulating, it suggests the opportunity is being recognized.
• Earnings Surprise (SUE) Percentile -- Has the company recently beaten earnings expectations? Positive surprises can trigger analyst upgrades and price re-rating.

Gate 4: Quality Floor

Is the business fundamentally sound?

This gate prevents the engine from recommending deeply discounted companies that are cheap for good reason -- businesses in structural decline, burning cash, or destroying value. It uses return on invested capital as a quality screen:

• ROIC at or above 8% -- Full pass (score of 1.0). The business earns an adequate return on capital, confirming the mispricing is driven by market sentiment rather than fundamental deterioration.
• ROIC below 8% but improving -- Partial pass (score between 0.5 and 1.0). The business is not yet earning its cost of capital but the trajectory is positive, suggesting a turnaround.
• ROIC below 8% and not improving -- Fail (score of 0.0). The business is destroying value with no signs of recovery.

Multiplicative Scoring

Within each track, gate scores are multiplied together rather than averaged. This is the single most important design choice in the scoring engine.

This mirrors how compounding works in practice. A company with a strong moat, high reinvestment rates, disciplined management, and a reasonable valuation will compound wealth. Remove any one of those ingredients and the compounding thesis breaks down. Multiplication captures this reality -- zero on any dimension means zero overall.

Composite Tiers

Continuous track scores are converted into discrete composite tiers through a gating system. Each tier requires progressively stricter thresholds:

| Level | Meaning | Recommended Action | |-------|---------|-------------------| | EXCEPTIONAL | Both tracks show extraordinary strength, or one track is in the top 1% | Deep fundamental research warranted | | HIGH | Strong score on at least one track | Evaluate as a serious candidate | | WATCHLIST | Moderate signals -- worth monitoring | Monitor for improvement, do not allocate | | NONE | Neither track shows sufficient evidence | No action |

Opportunity Types

The combination of track results determines the opportunity type, which signals what kind of investment thesis the stock represents:

| Type | Meaning | Typical Holding Period | |------|---------|----------------------| | Compounder | Qualifies on Track A only | 3-5+ years | | Mispricing | Qualifies on Track B only | 1-2 years (until re-rating) | | Both | Qualifies on both tracks (rare) | Strongest signal -- evaluate both theses | | Neither | Does not qualify on either track | Not recommended |

Compounder stocks are high-quality businesses expected to grow steadily over long holding periods. The investment thesis is that the business will compound shareholder wealth through operational excellence. Monitoring focuses on whether the moat is intact, reinvestment opportunities persist, and management continues to allocate capital well.

Mispricing stocks are undervalued relative to intrinsic value with a near-term catalyst. The investment thesis is that the market has temporarily mispriced the stock and a specific catalyst will close the gap. Monitoring focuses on whether the catalyst is materializing, the valuation gap is narrowing, and downside protection remains intact.

Both is the rarest and strongest classification. It means the stock is both a high-quality compounder and currently undervalued. These opportunities arise when the market punishes a fundamentally strong business due to temporary concerns -- an earnings miss, a sector rotation, or macro fear. When both theses are present, the position has both the long-term compounding foundation and the near-term re-rating catalyst.

Growth-Stage Adjustments

Not all companies are at the same stage of their lifecycle. A high-growth software company reinvesting aggressively should be evaluated differently from a mature dividend-paying utility. The engine adjusts gate weights based on the company's growth stage:

• High Growth -- More weight on reinvestment engine and moat evidence. Less weight on current capital allocation (high-growth companies often have minimal buyback or dividend history).
• Stable Growth -- Balanced weights across all four gates. This is the default configuration.
• Mature / Low Growth -- More weight on capital allocation and valuation. A mature company's returns depend more on disciplined capital deployment than on reinvestment runway.