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The Morningstar Rating for Stocks Do's and Don'ts

Here's how to correctly use this iconic measure.

You’re considering investing in company ABC. You’re familiar with the brand, and you know the company produces high-quality products. The company has been in business for decades and is clearly ahead of the competition. From everything you’ve heard on TV and from other people, there is a buzz growing about how the company is poised to keep growing over the next few years. There aren’t any lawsuits or media smears that you know of against the firm. All this makes you think that ABC is probably a great company to invest in, so you look up the details about it on Morningstar.com and--surprise!--it has a 1-star rating. What gives?

Ratings are often misunderstood--and that means they are often misused. It’s common for people to assume they know how to interpret a rating, and then when they find themselves in the wrong, they blame the rating for misleading them. A screwdriver is very bad at driving nails into walls, but that doesn’t make it a bad tool. To be a good builder, you need to know which tools are best for which job. Likewise, to be a smart investor, you need to know the right metric to use to answer the appropriate question. So today, I’m going to give you a crash course in how to read and interpret the Morningstar Rating for stocks so that you can use them to your advantage and avoid being led astray by false assumptions.

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