From having written this quarterly blog for nearly 4 years now, I know that people sometimes wonder whether analyst ratings and rankings are actually useful information. I suppose it depends on what you're hoping to use it for. I offer these blog posts to give people information they can use when thinking about portfolio construction -- a focus on high quality companies that an investor has strong confidence in regardless of what the market is doing and even regardless of whether the company itself is going through a rough patch. If we believe the tale often told that the most successful investor accounts belong to those who either forgot about their account or died, then we can surmise that buying and holding high quality companies is a reasonable path to success.
The "holding" part of that advice is often cited as the weak point: market weakness stokes fear, and people end up selling at the low. A simple suggestion for combatting that tendency is to hold companies you fundamentally believe in -- maybe its product is essential, maybe it's an iconic brand, maybe customers stick with the company's product because it's too much of a hassle to switch, maybe its financial strength is such that you have confidence it can weather a storm.
That's the spirit in which I offer this quarterly blog, and I work from the premise that if you find broad agreement on high ratings and rankings for a particular company, the chances are excellent that the company is high quality. In past blog posts I've generated lists of companies that might be considered the creme de la creme by limiting the search to only those with the highest ratings, and I've compared the highest ranking companies to companies that rank just one step lower. During the time I've looked at these ratings, doing searches using different criteria, it has been interesting to me that the same companies keep emerging as the highest quality; and those with just slightly lower ratings and rankings are often ones that most agree are very good companies, but perhaps not the very best companies.
This quarter I decided to revisit a post I did a couple of years ago in which I offered the analysts' own definitions of their ratings and rankings. When you have a clear understanding of the firm's approach to their ratings, you're in a better place to evaluate what they say about a given company. Below I provide their definitions and links. Following that, I summarize the ratings changes for my holdings this quarter and offer the full table of ratings and rankings for the stocks in my portfolio.
Rating and Ranking Definitions
Value Line Safety
"This rank measures the total risk of a stock relative to the approximately 1,700 other stocks. It is derived from a stock’s Price Stability index and the Financial Strength rating of a company. ...
Safety ranks are also given on a scale from 1 (Highest) to 5 (Lowest) as follows:
-Rank 1 (Highest): These stocks, as a group, are the safest, most stable, and least risky investments relative to the Value Line universe.-Rank 2 (Above Average): These stocks, as a group, are safer and less risky than most.-Rank 3 (Average): These stocks, as a group, are of average risk and safety.-Rank 4 (Below Average): These stocks, as a group, are riskier and less safe than most.-Rank 5 (Lowest): These stocks, as a group, are the riskiest and least safe.
Stocks with high Safety ranks are often associated with large, financially sound companies; these same companies also often have somewhat less-than-average growth prospects because their primary markets tend to be growing slowly or not at all. Stocks with low Safety ranks are often associated with companies that are smaller and/or have weaker-than-average finances; on the other hand, these smaller companies sometimes have above-average growth prospects because they start with a lower revenue and earnings base."
At the link above, Value Line also provides a table showing relative performance of stocks by rank during major market declines. For instance, during the great recession, stocks ranked 1 for safety declined 46.8%, stocks ranked 2 for safety declined 54.9%, and the S&P 500 declined 56.8%.
Value Line Financial Strength
"Value Line classifies 1,700 companies’ Financial Strength ratings... from A++ to C, in nine steps. ... Quite a few ingredients go into Value Line’s Financial Strength ratings. Balance sheet leverage, business risk, the level and direction of profits, cash flow, earned returns, cash, corporate size, and stock price, all contribute to a company’s relative position on the scale. The amount of cash on hand, net of debt, is an important consideration."
S&P Credit Rating
Most investors are familiar with S&P, Moody's, and Fitch credit rating firms. I admit that I use S&P's ratings because I have easiest access to them via my subscription to FAST Graphs. S&P explains their credit rating as "a forward-looking opinion about the creditworthiness of an obligor with respect to a specific financial obligation, a specific class of financial obligations, or a specific financial program (including ratings on medium-term note programs and commercial paper programs)." Below is a table showing the ratings and what they mean:
"The Morningstar Economic Moat Rating represents a company's sustainable competitive advantage. A company with an economic moat can fend off competition and earn high returns on capital for many years to come.
Morningstar has identified five sources of moat. Switching costs are those obstacles that keep customers from changing from one product to another. The network effect occurs when the value of a good or service increases for both new and existing users as more people use that good or service. Intangible assets are things such as patents, government licenses, and brand identity that keep competitors at bay. A company with a cost advantage can produce goods or services at a lower cost, allowing them to undercut their competitors or achieve higher profitability. Efficient scale benefits companies operating in a market that only supports one or a few competitors, limiting rivalry.
A company whose competitive advantages we expect to last more than 20 years has a wide moat; one that can fend off their rivals for 10 years has a narrow moat; while a firm with either no advantage or one that we think will quickly dissipate has no moat."
Morningstar Stewardship Rating
"Our corporate Stewardship Rating represents our assessment of management’s stewardship of shareholder capital, with particular emphasis on capital allocation decisions. Analysts consider companies’ investment strategy and valuation, financial leverage, dividend and share buyback policies, execution, compensation, related party transactions, and accounting practices. Corporate governance practices are only considered if they’ve had a demonstrated impact on shareholder value. Analysts assign one of three ratings: “Exemplary,” “Standard,” or “Poor.” Analysts judge stewardship from an equity holder’s perspective. Ratings are determined on an absolute basis. Most companies will receive a Standard rating, and this is the default rating in the absence of evidence that managers have made exceptionally strong or poor capital allocation decisions."
Portfolio Changes this Quarter
This quarter I finally fully liquidated the last shares of my position in KHC, and I also sold out of my position in WBA. I had held WBA and CVS as a combined position with WBA as the smaller holding, but CVS's forward-looking strategy and their 2 quarters of good earnings convinced me that while they've frozen the dividend, their prospects are looking brighter than WBA's. As a result, I'll no longer be reporting ratings and rankings for KHC or WBA.
This quarter there were only 2 ratings changes:
Table of Ratings and Rankings for My Portfolio
Below is the full summary table of the ratings and rankings for my holdings. Light orange highlighting indicates ratings that are lower than what I'm usually looking for; gray cells denote that no rating/ranking is available. (Note that neither SWKS nor TROW carry debt, so they don't have credit ratings. WTR doesn't have a credit rating, but its largest subsidiary, Aqua Pennsylvania, has a credit rating of A+.)