Singled Out for Stewardship: Firms With Exemplary and Poor Ratings

In researching stocks, investors might overlook a company's stewardship rating in favor of higher-profile measures, such as valuation metrics and moat rating. But make no mistake: A company's corporate stewardship rating matters, too, and can be an important indicator of whether management has investors' best interests at heart, not to mention an early warning system for potential trouble.

As a prime example of the importance of corporate stewardship, consider 
Hewlett-Packard's (HPQ) recent announcement that it was taking an $8.8 billion write-down related to its acquisition last year of British software maker Autonomy. HP officials blame Autonomy's accounting practices for the blunder, while shareholders have filed suit against HP, charging, among other things, that company officials were negligent in making the deal.

Morningstar assigns stewardship ratings to nearly 1,000 companies, giving them a ranking of exemplary, standard, or poor. Ratings are designed to reflect company management's performance as a steward of shareholder capital. The majority of companies receive a standard rating, but some are singled out for stewardship that is unusually good or unusually bad. Ratings are updated as needed.

Morningstar equity analysts assign the stewardship rating based on several factors, with an emphasis on how management chooses to allocate capital. Analysts look at a company's investment strategy, valuation, financial leverage, dividend and buyback policies, compensation, and other elements. You can read more about these criteria here.

Elizabeth Collins, a Morningstar equity analyst who helped revise the stewardship rating system earlier this year, recently authored a report looking at common factors among companies with various stewardship ratings. She found that exemplary ratings were more prevalent among companies with economic moats--wide moats in particular--and that poor stewardship was more often found among companies with no moat. A company's moat is a measure of its sustainable competitive advantages.

As an investor, keeping an eye on the stewardship rating of a stock you own or are considering buying may provide clues as to what you can expect from management. For example, HP carried a poor stewardship rating even before the Autonomy write-down was announced. That's not to say that companies with poor stewardship ratings will necessarily encounter problems or that those with exemplary ratings won't, but the ratings can provide useful insight into how the company you are invested in, or considering investing in, is run.

Stewardship ratings may be applied as a screen using Morningstar's  Premium Stock Screener tool. For example, if you wanted to look for companies within a given industry and with a given Morningstar Rating for stocks, but you wanted to make sure to avoid known stewardship issues, you could screen only on those with ratings of standard or exemplary.

Strong Stewards
Currently 91 companies carry a stewardship rating of exemplary, and Premium Members can see a screen of these stocks by clicking  here. Below are a few examples of companies in this group and why they were given that rating.

 Amazon.com (AMZN)
The online retailing giant earns high marks from Morningstar analyst R. J. Hottovy for its executive compensation policies, which include no golden parachutes for senior managers and a small salary with no equity compensation or bonus pay for chairman and CEO Jeff Bezos. The company's board of directors is elected each year, does not receive cash compensation, and avoids insider relationships. Amazon also creates transparency by providing supplementary financial data in its quarterly releases.

 Deere (DE)
The agricultural equipment manufacturer's focus on providing value to shareholders--including rewarding employees for meeting return-on-equity targets--earns it a high stewardship grade. The company has engaged in share repurchases below Morningstar's fair value estimate for the firm during the past several years. Morningstar analyst Adam Fleck says that, aside from slight goodwill impairments in recent years, Deere offers superior shareholder friendliness.

 U.S. Bancorp (USB)
The financial company's topnotch credit underwriting helped it emerge from the financial crisis without realizing a loss in any year. Its careful approach to acquisitions has also benefited shareholders. U.S. Bancorp has realized strong returns on equity under CEO Richard K. Davis.

Room to Improve
Premium Members also can see a screen of the 75 stocks that currently carry poor stewardship ratings by clicking  here. Below are examples of these companies and why they carry that rating.

 Best Buy (BBY)
The consumer electronics retailer's new CEO, Hubert Joly, replaced former CEO Brian Dunn, who resigned in April following the launch of an independent investigation into personal conduct allegations. Joly's proposed compensation package, valued at $20 million, is excessive, says Hottovy. Adding uncertainty to the company's financial picture is founder Richard Schulze's proposal to acquire the 80% of company shares he doesn't already own, thus taking it private. 

 Clear Channel Outdoor
Minority shareholders of this outdoor advertising company have no real voice in corporate governance as 89% of the company's shares are owned by CC Media, a debt-heavy entity owned by a private equity consortium. CC Media's recent decision to issue a special dividend helps itself while adding to Clear Channel Outdoor's debt load.

 Ameren (AEE)
Management of this public utility holding company has struggled to create shareholder value in recent years, significantly underearning returns allowed under regulations. Also, management has made poor capital-allocation decisions at its merchant generation unit and has failed to provide meaningful dividend growth for investors.