New Monitored List, New Rating
Today, our neutrality ends.
Check out this week’s Monitored List and you’ll see a series of changes, most notably our abandoning of the Neutral and Underperform ratings in favor of A, B, and C ratings.
Below, we’ll address the changes, why we made them, and how they will help you get the most out of your subscription to the Forecasts.
Historically, we have maintained the Monitored List in an effort to cover important stocks that we do not like enough to add to our buy lists. That goal remains intact. However, we believe A, B, and C ratings provide more actionable advice.
No more Neutrals
Neutral was a fairly accurate description of our opinion on most of the monitored stocks, as we prefer to invest only in stocks we like a lot. But some Neutrals look better than others, and the new system allows us to provide a more specific opinion on stocks that do not qualify for Buy or Long-Term Buy ratings.
The new ranks are similar to those we use in the quarterly Utility Update. Stocks rated A (above-average) have the potential for market-beating 12-month returns. Stocks rated B (average) are expected to roughly match the market, while a C rating (below-average) implies either expectations for below-market performance or an uncomfortably high level of risk. All stocks on our buy lists earn an A rating.
If we ranked every stock in our roughly 3,800-stock research universe, we’d award a lot of B ratings, with a smaller number of A and C ratings. But we don’t cover every stock. Our Monitored List contains 145 companies, of which 55 are rated A, 61 are rated B, and the remaining 29 are rated C. Why so many A ratings? Here are three reasons:
• The Forecasts focuses mostly on large-cap stocks, which tend to score well in Quadrix. On average, S&P 500 Index stocks earn a Quadrix Overall score of 61, versus an average of 58 since 1990. The 50 largest stocks in the index have historically earned even higher scores, averaging an Overall score of 65. However, those 50 currently average a score of 72.
• All of our recommended stocks earn an A rating. Some of them are fairly small and would not qualify for the Monitored List if we didn’t include them on our buy lists. The inclusion of these smaller A-rated stocks skews the distribution.
• When choosing between similar stocks to include in the Monitored List, we selected companies we thought had a better chance of becoming Buys in the future. As such, we were predisposed to selecting high-quality stocks, many of which earn A ratings.
A’s versus Buys
So what separates an A rating from a Buy rating? The depth of our conviction about the stock.
While we expect A-rated stocks to outperform, we’re simply not convinced they represent one of our top 25 to 30 picks. Sometimes we’ll find several attractive stocks in an industry group. All may be worthy of consideration, but we generally choose just one or two favorites for the Buy List.
Thus, the A, B, and C ratings are not a substitute for our traditional Buy and Long-Term Buy ratings. We think our buy lists represent the best strategy for stock investing, but we also realize that many readers prefer to build their own portfolios. If that’s your predilection, we suggest starting with A-rated stocks.
To determine the A, B, and C ratings, we started with the same tool we always use — the Quadrix stock-rating system. Ratings will typically correspond to Quadrix Overall scores, with higher-scoring stocks earning a higher rating. But not always.
Quadrix is a backward-looking quantitative system, and it doesn’t always tell the whole story. We also look at each stock individually, considering such factors as growth prospects for the company and for its industry, changes in the market, competitive and regulatory issues, and recent news not yet reflected in the statistics used to compute Quadrix scores.
In recent months, our Monitored List has featured about 200 stocks. Today, there are 145 stocks on the list. We dropped coverage of many of our smaller stocks. Historically, after dropping a stock from our buy lists we have continued to cover it as a Neutral. Expect less of that going forward. Our goal is to cover the biggest stocks in the market, plus a select group of smaller industry leaders. And as discussed above, we’re providing more useful ratings on every one of our monitored companies.
Today’s Monitored List covers all U.S. stocks with stock-market values of more than $30 billion — except Burlington Northern ($99; BNI), which is being acquired by Berkshire Hathaway ($3,327; BRKb) — and 75% of stocks with market capitalizations of at least $15 billion. Our Monitored List contains about 56% of the entire market capitalization of U.S. stocks.
These changes to the Monitored List allow us to tighten our research coverage to focus on the most important stocks. We will continue to look for opportunities among all stocks with market capitalizations of $2.5 billion or higher, but smaller stocks will not make it to the Monitored List unless they qualify as Buys or provide us with something truly unusual, like exposure to a unique market.
What makes a rating
While we’ve discussed what A, B, and C ratings mean, nothing provides a better picture of our thinking than an example. In the following paragraphs, we review three stocks from the same industry with different ratings.
General Dynamics’ ($69; GD) three defense segments reported higher revenue in the nine months ended September, offsetting weak sales of the popular Gulfstream business jet. New jets sell best when corporate earnings are robust and the used-jet market is stable — and conditions for both appear to be improving.
The company is expected to deliver roughly flat profits for 2009, followed by 5% growth this year. At just 11 times trailing earnings, the stock trades 28% below its five-year average P/E ratio. General Dynamics is rated A. It is also a Buy and a Long-Term Buy.
Lockheed Martin’s ($78; LMT) solid Quadrix scores are supported by an appealing valuation and sturdy growth history. But the stock is down over the last six months, missing out on much of last year’s marketwide rally. Wall Street expects lower profits this year, and the company’s government programs are more vulnerable to cuts in the defense budget than those of General Dynamics. Lockheed Martin is rated B.
Boeing’s ($58; BA) 787 Dreamliner jet finally took flight after more than two years of delays, but the stock appears vulnerable after last year’s steep ascent. Per-share earnings have missed the consensus in three of the last four quarters. Wall Street expects per-share profits to nearly triple this year, an aggressive target even for this strongly cyclical company. Earning an Overall score of 29, Boeing is rated C.