Morningstar's Picks: How Our Ratings Work

Morningstar takes a long-term, fundamentals-based approach when evaluating investment opportunities. Our forward-looking ratings are driven by our analysts, who follow their companies and mutual funds day in and day out. As a result, coverage is constant and ongoing: Analysts review their companies and funds regularly. And they act swiftly to put securities under review when news breaks that may change our take on the fundamentals.

While both analyst-driven and fundamentals-based, our stock and fund ratings are arrived at differently. Here's a snapshot of each.

The Morningstar Rating for Stocks Morningstar rates stocks on a 1- to 5-star range. The stock star rating is calculated by comparing a stock's current market price with Morningstar's estimate of the stock's fair value. The bigger the discount, the higher the star rating. Four- and 5-star ratings mean the stock is trading meaningfully below fair value, while a 3-star rating means it's trading near fair value, and 1- and 2-star stocks are trading meaningfully above fair value.

Our rating system also factors in an uncertainty adjustment (known as the Fair Value Uncertainty rating). Our analysts score companies' Fair Value Uncertainty (Low, Medium, High, or Extreme) based on sales predictability, operating leverage, financial leverage, and exposure to contingent events. As the Uncertainty rating goes up, so does the discount we require in order for a company to earn a 4- or 5-star rating, given the lower confidence in the precision of our fair value estimate.

Learn more about the Morningstar Rating for Stocks here.

The Analyst Rating for Funds The Analyst Rating for funds reflects Morningstar's forward-looking analysis of a fund. Morningstar analysts assign the ratings on a five-tier scale with three positive (Medalist) ratings of Gold, Silver, and Bronze; a Neutral rating; and a Negative rating. The Analyst Rating is based on the analyst's conviction in the fund's ability to outperform its peer group and benchmark on a risk-adjusted basis over the long term. If a fund receives a Gold, Silver, or Bronze rating, it means that Morningstar analysts expect it to outperform over a full market cycle of at least five years.

The ratings reflect how well a fund performs on a series of fundamentals, which we call "pillars": People, Process, Parent, Performance, and Price. Morningstar thinks that these five areas are crucial to a fund's long-term success.

Learn more about the Analyst Rating for Funds here.