The mosaic theory is an approach to financial security analysis that involves the analysis of a variety of resources, including public and non-public material and non-material information, to determine the underlying value of a security.
The theory provides a more comprehensive and meticulous approach to the valuation of financial securities because it allows the inclusion of a broader range of information sources. At the same time, the method is extremely complicated, as it requires the integration of information that may not seem relevant to a security’s price.
An analyst who relies on the mosaic theory must carefully assess the information used in valuation analysis. Due to the fact that the method allows the use of non-public information, there is a chance that an analyst may cross the line and use material, non-public information in the analysis, which is strictly prohibited under existing securities laws.
In case of illegal use of material, non-public information, an analyst may face charges related to insider trading practices. Therefore, everyone who uses such information in valuation should carefully evaluate the sources of information.
The CFA Institute recognizes mosaic theory as a valid method of security analysis.
Material information vs. Non-material information
The distinction between material and non-material information is quintessential in mosaic theory because it draws the line between legal and illegal activities.
1. Material information
This is the information that exerts a certain (even small) effect on the price of a security. Whenever a piece of material information becomes available to the public, it turns into a catalyst that causes price changes in a security. Only public material information can be used in the security’s analysis.
The use of private material information in security valuation is a criminal offense. The most common examples of material information are the announcement of dividends, quarterly earnings, management changes, and M&A activities.
2. Non-material information
Non-material information is information that does not affect the price of a security. It does not directly change a security’s price but may provide some insights to an analyst regarding the possible future performance of the security. Some examples of non-material information include levels of employee satisfaction, the company’s popularity in Internet searches, etc.
Examples of information sources in Mosaic Theory
In the modern world, large amounts of data are easily accessible. Therefore, analysts may use various sources that may help them to identify the underlying value of a security. Examples of information sources that can be used by analysts who rely on the mosaic theory may include:
Social networks (e.g., Facebook, LinkedIn, Glassdoor)
Insights from the company’s management and employees
Insights from other analysts or industry professionals
Thank you for reading CFI’s explanation of the Mosaic Theory. CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below: