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 Morningstar.com.au, 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...

Exclusive: An interview with Westpac CEO, Brian Hartzer - Part 3
20/07/2017  Insights on Australia's housing market, China's effect on domestic banks, and cyber-security readiness, in the final instalment of Brian Hartzer's interview with Morningstar's David Ellis.
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.
Exclusive: An interview with Westpac CEO, Brian Hartzer - Part 2
13/07/2017  Westpac CEO Brian Hartzer joins Morningstar banking analyst David Ellis to discuss digital disruption, regulatory change and Australian banks' social license.
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.
Exclusive: An interview with Westpac CEO, Brian Hartzer - Part 1
06/07/2017  Brian Hartzer, CEO, Westpac joins Morningstar senior analyst David Ellis to discuss his role leading Australia's oldest bank, how Westpac can continue to grow value, and its commitment to sustainability.
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
How to guard against retirement threats
16/06/2017  As retirement approaches, even the best-laid plans can go awry, as Tim Steffen tells Christine Benz, Morningstar US.
PIMCO Global Credit Fund
07/06/2017  The PIMCO Global Credit strategy receives a Morningstar Analyst Rating of Silver due to its sizeable and highly capable credit research team.
PIMCO Income Fund
07/06/2017  Morningstar's Tim Wong looks at the strengths and competitive advantages of this Silver-rated strategy.
3 pockets of opportunity in fixed income
07/06/2017  The head of PIMCO Australia portfolio management explains his views on active management in fixed income and outlines where he sees most value in this space.
Trump administration biggest macro threat for investors
05/06/2017  Even as European political volatility subsides, the US Government remains a considerable threat to financial markets, says Colleen Barbeau, director of equity portfolio management, Franklin Templeton.
Antipodes Global Fund: Class P
01/06/2017  Antipodes constructs this portfolio based on three major objectives--capital preservation, inclusion of attractively priced businesses, and investment resilience.
Investors Mutual WS Future Leaders Fund
01/06/2017  Investors Mutual Future Leaders is a capable strategy focused on investing in Australian companies outside the top 50.
Why the time is right to invest in India
25/05/2017  Indian stocks rallied after the appointment of Narendra Modi as Prime Minister--but then subsequently fell. UK-based investment manager Jonathan Schiessl says now is the time to buy.
When should you pay active fund fees?
23/05/2017  When is it worth paying higher fund fees for active fund management? The single most important factor effecting a fund's relative performance is its price.