Introducing star ratings to Morningstar Australasia equity research

Adam Fleck  |  27/04/2017Text size  Decrease  Increase  |  

Adam Fleck: We're making a change to our recommendation system away from the buy to sell ratings to our 5-Star Rating system. Importantly though, our system remains forward-looking and based on our analysts' opinion of valuation. It's ultimately still the price to fair value estimate combined with the uncertainty ratio that drives our 5-Star Ratings.

I think it's important to note that a 3-Star Rating, which we previously referred to as a hold, still conveys our opinion that investors are likely to receive a fair rate of return, roughly the cost of equity.

It also means a 5-Star Rating means our analysts think there is a high likelihood that the returns of the company over the next several years will outpace that required rate of return.

Whereas a 1-Star Rating, which we used to call a sell, means that analysts think there is a high likelihood that investors will not enjoy a fair rate of return. That doesn't mean that the company is a poor-quality company. We just don't think the investment opportunity is pricing in a margin of safety at this point.

We're making this change to acknowledge the fact that our investors may use our valuation opinion in conjunction with some of our other ratings. For instance, an investor who is looking for high-quality companies trading at a discount, may seek out wide moat firms with 5-Star ratings. Our current buy, sell or hold recommendation doesn't account for this flexibility in making that decision for investors.

Ultimately, we're approaching our research process the same way as we were before. We seek to answer two questions. Is this company a quality company as measured by our economic moat rating? And is this investment opportunity of the stock a high-quality stock as measured by the price-to-fair value ratio?

Nothing about that is going to change. Our 5-Star Rating will remain forward-looking just like our buy, sell or hold recommendations did.

Nothing about this change will alter how we view the moat rating or our fair value estimate. The economic moat rating remains our confidence in a company's ability to sustain its return on invested capital as driven by its competitive advantage.

That won't change at all nor will our fair value estimate. Our fair value estimate is based on the future cash flows of a company discounted back to today.

What that means, of course, is that our fair value estimate should go up slightly over time as stocks rise with their cost of equity. While we compare the current market price to our fair value estimate to ultimately arrive at our Star Rating, the process behind the estimation of that valuation is not going to change.

All of Morningstar's products will reflect this Star Rating change that includes, Advisor Research Center, Your Money Weekly as well as our Email Distribution System. Ultimately, investors will see our Star Rating instead of our word-based buy to sell rating, but our economic moat, our fair value estimate and importantly, the research that underlies those assumptions will remain exactly the same.

We are aiming to make this change by the end of 2017 sometime in the fourth quarter. We continue to offer our help and communication around this change, but it will ultimately be a change in all of our products.

Video Archive...

Did lack of transparency cause the financial crisis?
19/09/2017  Ten years after the collapse of Northern Rock, Andy Agathangelou tells Emma Wall that greater transparency in financial services could ward off a second global financial crisis.
Are we facing another Global Financial Crisis?
19/09/2017  Ten years on from the collapse of Northern Rock, Dan Kemp tells Emma Wall how there are echoes of the crisis in markets today.
Wild ride in FY17 and more to come - part 2
13/09/2017  Morningstar's Peter Warnes discusses how you may want to position your portfolio in FY18, as geopolitical storms continue to rage and safe-haven assets feel the effects.
Wild ride in FY17 and more to come - part 1
12/09/2017  Cost-out remained a dominant theme for large-cap Australian companies in FY17, and looking ahead to FY18, they should be clearer on cap-ex, says Peter Warnes, Morningstar’s head of equities research – Australasia.
Deeper demand driving these pooled investments
31/08/2017  Listed investment trusts are beginning to take off in Australia, but exactly what are they and how do they differ from listed investment companies and managed funds?
Upbeat Woolies result tempered by Big W
30/08/2017  Woolworths' category-topping FY17 result driven by surprisingly strong sales, even as sector faces tougher times ahead, explains Morningstar's Johannes Faul.
Coke Amatil 1H17 result leaves margin of safety
28/08/2017  A challenged earnings announcement from Coca-Cola's Australian-listed business was largely expected, but downside is already priced in and improvements are expected in FY18.
How slashed Telstra dividend affects our outlook
23/08/2017  Brian Han remains reasonably positive on the telco giant even after some disappointments in the FY17 earnings announcement.
Earnings season FY17 mixed bag so far
18/08/2017  Aside from a few high-profile earnings guidance misses, large-cap stocks are doing okay as FY17 reporting season passes halfway, says AMP chief economist Shane Oliver.
Rio Tinto posts mixed result for 1H17
10/08/2017  An interim result of US$3.9 billion in net profits after tax for one of the world's largest mining companies was positive but slightly weaker than expected, even alongside a record dividend, explains Morningstar's Mat Hodge.
Kerr Neilson on why global investment exposure is key
07/08/2017  There are two types of investors, regardless of market noise, imputation credits, diversification approaches and market indices, says the managing director of Platinum Asset Management.
Finding fixed income opportunities in new paradigm
02/08/2017  Slowing economic growth in the US and parts of Europe emphasises the need to carefully select credit opportunities, says Vincent Reinhart, chief economist, Standish Mellon Asset Management.
Telstra won't be blown away by headwinds
17/07/2017  While it faces what Morningstar equity analyst Brian Han describes as a whirlwind of negatives, he suggests investors shouldn’t hang up on Telstra.
The home-truths of investing
12/07/2017  Look for companies that sit outside the cycle; heed the lessons of history; and remember the power of compounding, says Bennelong's Neale Goldston-Morris.
Self-managed super is not Do-it-yourself
03/07/2017  There are a few common pitfalls in running a self-managed super fund that mean trustees shouldn't go it alone entirely, says BT Financial Group's head of financial literacy, Bryan Ashenden.
Investing to protect on the downside
30/06/2017  There are investment strategies you can adopt to mitigate volatility-linked fear and uncertainty in markets, explains Roy Maslen, chief investment officer – Australian equities, AllianceBernstein.
Don’t overdo benchmark consideration
28/06/2017  Being benchmark agnostic is the most effective approach to fixed income investing, according to Anujeet Sareen, portfolio manager, Brandywine Global.
Factor-based investing using ETFs
26/06/2017  Investors should consider style-exposures--such as value, defensive or yield-- they would like in their portfolios, explains Jonathan Shead, head of portfolio strategists – Asia Pacific, State Street Global Advisors
Volatility plays to active manager strengths
--  The climate of political volatility in the US holds important implications for investors and the funds they invest in, particularly around Donald Trump's ability to pass legislation through Congress, says Pimco's Libby Cantrill.
Is the FTSE 100 Facing Another Market Crash?
16/06/2017  Ten years on from the pre-crisis FTSE 100 high, Morningstar UK's Emma Wall examines how UK stocks have fared