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Morningstar Stock Grades

This is a proprietary Morningstar data point.

The Morningstar stock-grading system consists of three grades, one in each of the following categories

  • Growth
  • Profitability
  • Financial Health.

They're meant to be a quick way to get a handle on a company's fundamentals.

All grades are based on relative rankings of companies within their sector. Morningstar uses the 12 Morningstar sectors.

For example, a company in the financial services sector that receives an "A" in growth is a company that ranks near the top of the financial services sector in terms of growth. Sector comparisons are used to make sure comparisons are apples to apples.

The grades are based solely on the numbers reported by the company in its SEC filings. Due to accounting conventions, however, these grades may or may not reflect the underlying economic reality, and investors should view the grades as a starting point for analysis rather than a definitive judgment on the company. No Morningstar analyst makes a subjective call as to what grade a company should get.

Distribution of grades: Within each sector for each of the three categories (growth, profitability, and financial health), Morningstar gives equal numbers of companies As, Bs, Cs, and Ds, while the bottom 10% get Fs.

Note that there's no grade inflation. A grade of "C" means a company ranks right around the middle of its sector. It's therefore very tough to get straight "A"s.

All information used to calculate the grades comes from Morningstar's internal equities database.

Growth Grade

The growth grade consists of three components, which are weighted to arrive at an overall growth grade:

Raw Growth

Morningstar looks at historical sales growth over the past five years. The faster a company's growing, the better.

Trend

Morningstar rewards companies whose sales growth is speeding up and punish those whose sales growth is slowing down.

Consistency

Morningstar rewards companies with steady year-by-year sales growth over the past five years, and punish those with volatile sales growth.

Profitability Grade

The profitability grade consists of three components, which are weighted to arrive at an overall profitability grade:

Raw Profitability

Morningstar looks at the average level of a company's returns on capital over the past five years. The higher the better.

Trend

Morningstar rewards companies whose returns on capital are trending upward.

Consistency

Morningstar rewards companies with consistent returns on capital, and punish those with volatile profits.

Financial Health Grade

The financial-health grade consists of two components, which are weighted to arrive at an overall financial-health grade.

Raw Financial Health

Morningstar looks at financial leverage (assets/equity) from the most recent quarter's balance sheet, cash on the balance sheet, cash flows, and free cash flows to arrive at a financial-health grade.

Trend

Morningstar punishes companies with deteriorating financial health.

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