Using the S&P Quality Ranking
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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?
As long-term investors, we look for
quality growth companies
What does quality looks like?
Is it well managed?
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
SSG on training wheels
Looks at a sample of the past 7 years
Quick cut; “Wrong” years can lead to
misinterpretation
Take Stock software
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
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
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.
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:
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
Formally known as S&P Earnings and
Dividend Ranking
Proprietary measure started in 1956
Attempts to measure Graham & Dodd’s
sustainable earnings power
Measures long-term growth and
stability of earnings and dividends.
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
Simple and quick way to determine if
company is worth studying
Simple and quick way to determine if
company is worth keeping
Screening Shorthand
Portfolio Management Shorthand
Uses letter grades
8 in total
Remember to do your own research!
10
Where To Find It
Two places:
S&P Company Report (aka “tearsheet”)
On-line Premium Service (OPS)
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 *
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 *
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
18
S&P Quality as a Cross Check
Can Be Found
In the Portfolio
Portion of Stock
Analyst
19
Benefit of S&P Quality Rating
Combines some key
aspects of the SSG
Growth and stability
of earnings
Growth and stability
of dividends
20
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
Top Return to Risk Was Not Found in stocks
with the highest ranking, “A+”
Two notches below, “A-”, preformed best.
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
Also favors companies paying a dividend
Lowest they earn is a “B-”
Penalizes young small companies
Highest they earn is a “A-”
Good companies > 10 years may not be ranked
No ranking of foreign companies
Used only on US based companies
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Final Thoughts
S&P Quality Ranking has …
No price component
Therefore no “buy” or “sell” aspect as
found in other S&P proprietary measures
(STAR & Fair Value/Outlook)
No projected return
As in Sec. 5c of the SSG
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
Use in conjunction with other metrics
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
The visual analysis
Evaluating Management
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What We Learned
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
Brain Lewis articles
ICL list (NAIC Chat room – free to
anyone)
Sept. 04 Better Investing (BI)
Aug. 04 BITS (expanded article)
August 12 to 23, 2004
www.standardandpoors.com
Equity Research (near top)
Analytical Methodology (left side)
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