Transcript Using the S&P Quality Ranking

Finding Quality:
Getting a 2nd Opinion
(or How To Use the S&P Quality Ranking)
By Kevin Gillogly
For Happy Destiny Investment Club
July 2005
Measuring Managerial Ability
“A statement of actual earnings, over a
period of years, with a reasonable
expectation of that these will be
approximated in the future. The record
must cover a number of years, first
because a continued or repeat performance
is always more impressive than a single
occurrence, and secondly because the
average of a fairly long period will tend to
absorb and equalize, the distorting
influences of the business cycle.”
– Benjamin Graham and David Dodd
Security Analysis
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What is Quality?
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As long-term investors, we look for
quality growth companies
What does quality looks like?
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Is it well managed?
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On the SSG it is consistency of Sales, PreTax Profit (PTP) margins, and EPS
On the SSG it is the trends on the graph
and in Sec. 2 (Evaluating Management)
Want a 2nd opinion?
Where do you turn?
3
Finding Quality
Myriad ways to find quality without doing a SSG.
Not one is perfect. All have some limitations.
 The Stock Check List
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SSG on training wheels
Looks at a sample of the past 7 years
Quick cut; “Wrong” years can lead to
misinterpretation
Take Stock software
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Shows the Better Investing concepts in 4 clicks
Goes through quality points found on the SSG
Can be conservative; Can miss some good
choices
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Other Forms of Quality
Non Better Investing forms:
 Kausch Meisheri’s Quick Analysis
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Looks at the trends of the past 10 years worth of
Value Line (VL) data
Quick cut; but can’t tell if the price is right
Mark Robertson’s 60 Second Equity Analysis
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Also uses VL data
A Quality Ranking that can be compared across
industries and uses projections in the calculations
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How Strong Are These Companies?
Most of the previous metrics look at sales,
EPS and margins.
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What about financial stability?
How strong is management?
Can a company survive a financial hit?
Where do we turn?
metric n., a system of measurement
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Looking For Independent^
Quality Ratings*
Sources:
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Morningstar Stock Investor
 Newest on block
 Uses “Stewardship” grade & Star Rating
Value Line
 Peter Lynch “like hiring your own analyst”
 Financial Strength & Earnings Predictability
Standard & Poor’s
 Used by founders of Better Investing
 Quality Ranking
^ = reputable w/ no brokerage business
* = no price component
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S&P Quality Ranking
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Formally known as S&P Earnings and
Dividend Ranking
Proprietary measure started in 1956
Attempts to measure Graham & Dodd’s
sustainable earnings power
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Measures long-term growth and
stability of earnings and dividends.
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See quote on page 2
Focus is on the last 10 years worth of data
Covers over 3,500 US based companies
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Why Use It?
According to back-testing by S&P when
compared to lower ranked companies, high
quality rankings have:
 Less risk;
 Lower debt levels, higher profit margins and
higher return on equity;
 Less likely to engage in accounting
manipulations;
And
 Outperformed the S&P 500 index
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How To Use It
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Simple and quick way to determine if
company is worth studying
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Simple and quick way to determine if
company is worth keeping
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Screening Shorthand
Portfolio Management Shorthand
Uses letter grades
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8 in total
Remember to do your own research!
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Where To Find It
Two places:
 S&P Company Report (aka “tearsheet”)
 On-line Premium Service (OPS)
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Can drop straight into Toolkit (TK5), Stock
Analyst (SA 3.1), and Prospector (NSP 2.6)
Not available in Classic (NCP 2.3)
Can also be used in MS Excel
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S&P “Tearsheet” For Most Companies
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S&P “Tearsheet” For Smaller Companies
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S&P Quality in Stock Analyst
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S&P Quality in Toolkit 5
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Translating the Grades *
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A+
A
AB+
B
BC
D
LIQ
NR
Highest
High
Above Ave.
Average
Below Ave.
Lower
Lowest
In reorg.
Liquidation
Not Ranked
( 2%; 81 companies)
( 6%; 204)
( 6%; 233)
(16%; 576)
(19%; 702)
(26%; 966)
(24%; 872)
( 1%; 36)
(3670 companies)
* Source: OPS 3705 cos. w/ Quality Rank Jun 05
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Translating into NSP *
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A+
A
AB+
B
BC
D
NR
Highest
High
Above Ave.
Average
Below Ave.
Lower
Lowest
In reorg.
Not Ranked
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7
6
5
4
3
2
1
0
* NAIC Stock Prospector
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S&P Quality as a Cross Check
Can Be Found
 In screening of
Prospector
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S&P Quality as a Cross Check
Can Be Found
 In the Portfolio
Portion of Stock
Analyst
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Benefit of S&P Quality Rating
Combines some key
aspects of the SSG
 Growth and stability
of earnings
 Growth and stability
of dividends
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Limitations of S&P Quality
Rating
Misses key aspects of the SSG
 No forecast of future Sales &
EPS growth rates
 Does not help determine
future value
Misses key aspects of the SCG
 Measuring to its peers
 Measuring the better return
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From Quality to Performance
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Top Return to Risk Was Not Found in stocks
with the highest ranking, “A+”
Two notches below, “A-”, preformed best.
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Price Premium of top ranking
That’s still leaves over
200 companies (with a
ranking of A-) to
examine that could be
potential purchases
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Quality to Performance
S&P Quality Ranking will not help finding
undiscovered “gems” of the stock market:
 Penalizes companies not paying a dividend
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Also favors companies paying a dividend
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Lowest they earn is a “B-”
Penalizes young small companies
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Highest they earn is a “A-”
Good companies > 10 years may not be ranked
No ranking of foreign companies
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Used only on US based companies
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Final Thoughts
S&P Quality Ranking has …
 No price component
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Therefore no “buy” or “sell” aspect as
found in other S&P proprietary measures
(STAR & Fair Value/Outlook)
No projected return
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As in Sec. 5c of the SSG
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Which is our reason for studying stocks
Use as your starting point
First cut
Remember it’s limitations
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Final Thoughts
Use the S&P Quality Ranking …
 Like a pilot use your instruments
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Use in conjunction with other metrics
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Several different gauges to tell the same thing
VL Financial Strength
Quick Analysis
60 Second Equity Analysis
It is ok to have overlap
Cross-check your work on the SSG
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The visual analysis
Evaluating Management
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What We Learned
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The Value of a simple
quality metric
How To Eliminate Stocks
Before Doing a SSG
How To Monitor Existing
Stocks
Another use for OPS
Another Benefit of using
NAIC Software
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Questions?
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Further Reading
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Brain Lewis articles
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ICL list (NAIC Chat room – free to
anyone)
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Sept. 04 Better Investing (BI)
Aug. 04 BITS (expanded article)
August 12 to 23, 2004
www.standardandpoors.com
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Equity Research (near top)
Analytical Methodology (left side)
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