On a Scale of One to Five
by william_lako
 Money Talks Blog
February 08, 2013 12:28 PM | 1654 views | 0 0 comments | 75 75 recommendations | email to a friend | print | permalink
One of the fundamental steps when developing a portfolio is to know what you are buying.

If you’ve researched stocks, you’ve likely come across a section offering “Analyst Opinions” with either a numerical or alphabetical score.  When you are using an outside source for an opinion on a stock, you should always check to see what the information being provided means. Most information providers define their ratings or rankings to make it somewhat clear as to what they represent.

For example, on Yahoo Finance, the “Analyst Opinion” is provided by a third-party source, Thomson Reuters. The Thomson rating is a numerical score from 1 to 5, with the lower score being the most favorable. The number actually reflects the average analyst opinion on the stock. Thus, if one of the analysts polled by Thomson rates the company a “Buy,” it receives a 1 rating from that analyst; a “Sell” opinion would garner a 5 rating. Once all opinions are made, the numerical average provides the rating you see in Yahoo Finance.

Paid rating services like Value Line provide a large amount of information, including a Safety Ranking and Financial Strength rating. For a specific stock, the Safety Ranking will be from 1 to 5, with 1 being the best rating (safest), while the Financial Strength rating ranges from A (best) down to C (worst). Financial Strength is a measure of the financial position of the company. Low debt or the ability to easily service its debt, high levels of working capital, and solid earnings potential, are the attributes of a financially strong company. The Safety Rating is derived from the Financial Strength and the stock’s price stability.

Morningstar.com is a good resource for mutual fund research, as is the fund’s own prospectus. Morningstar has a widely respected rating system by which the company rates mutual funds from one to five stars with, more stars meaning a more desirable investment fund. Again, the Morningstar website lays out the criteria for their ratings, but in a nutshell the rating measures funds against their style group peers —i.e., other funds that share the same investment objective or market capitalization—on the basis of returns and risk.

Lipper also provides a numerical rating on mutual funds as seen in the Wall Street Journal, MarketWatch.com and Barron’s. Their rating system is fairly simple with a range of 1 to 5 being assigned to funds on the basis consistency, preservation, tax efficiency and expense with an overall score. An overall Lipper score of five is best, but the rating system adds value by showing the additional ratings.

Overall, ratings for both stocks and mutual funds vary from one service to the next, as each will use various methods and emphasize different factors. When researching an investment, you may want to consult several, rather than relying on just one.

William G. Lako, Jr., CFP®, is a principal at Henssler Financial, and a co-host on Atlanta's longest running, most respected financial talk radio show "Money Talks" airing Sundays at 10 a.m. on Talk 920 AM, WGKA.

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