MORNINGSTAR TAKES STOCK OF ABCS –AND DEFS — IN NEW EQUITY RATINGS; BUT NO STARS, PLEASE, THEY’RE JUST FOR FUNDS

Stocks are going to get the Morningstar Inc. treatment starting next quarter.

The Chicago-based rating service in July will start evaluating nearly 8,000 stocks and give them grades of A through F in key performance areas. The stocks are graded against others in their sector.

The service, in the works since last year (Investment News, March 9, 1998), is being aimed at individual investors and advisers who want to demonstrate to their clients the strengths and weaknesses of different equities. In this new endeavor, Morningstar is hoping to build off the popularity of its influential star rating system for mutual funds.

“We want to appeal to people who got their feet wet with mutual funds,” says Morningstar president Don Phillips. “We’re trying to cut through the more esoteric aspects of equity investing.”

The stock rating initiative fits into a broader effort by Morningstar, which had an estimated $44 million in revenue in 1998, to branch into areas beyond mutual fund coverage. For instance, it plans to start rating mutual fund companies (InvestmentNews, May 10) and recently hired a person to develop tools and programs for investment advisers.

The stock grades augment Morningstar’s current equity coverage. Starting in July the ratings will be bundled into the monthly publication Morningstar StockInvestor and the CD-Rom Principia for Stocks.

James Budros, a principal in the fee-only advisory firm Budros & Ruhlin in Columbus, Ohio, says the new service is timely, since investors are eyeing individual stocks.

“Morningstar has its finger on the pulse,” he says.

“While Morningstar probably won’t bring any revolutionary information to the marketplace, its brand has such acceptance that it probably will have an impact.”

Louis Thompson, president of the National Investor Relations Institute in Vienna, Va., says the ratings could be a valuable resource to consumers but should be complemented by more fundamental information.

“This could be useful information,” he says. “I wouldn’t rely on that solely in making a decision, but certainly it would be a useful ingredient in making a decision.”

Competitor Jean Buttner, chief executive of New York’s Value Line Publishing, long considered the leader in rating stocks for individual investors, doesn’t expect Morningstar to threaten her company’s position.

“They would have a long way to go to give us competition in rating stocks,” she says.

Morningstar plans to measure the stocks according to four criteria: growth, profitability, financial health, and valuation.

numbers and trends

To gauge growth, the company will run a quantitative analysis that looks at absolute level of sales increases, the trends in sales and their consistency, says Haywood Kelly, an analyst for Morningstar.

The company will take into account similar criteria — absolute numbers, trends and consistency — in measuring profitability, then compare the stock price to profitability, as well as return on capital, to determine valuation, Mr. Kelly says.

For financial health, the company will evaluate companies according to levels of debt and the strength of cash flow, he adds.

“We want to help people understand stocks,” Mr. Kelly says. “We’re not in the business of telling people what to do.”

Morningstar emphasizes that its mutual fund ratings aren’t meant as imperatives to buy or sell, he adds, but “nobody listens.”

The decision to evaluate stocks according to individual characteristics, rather than overall performance, explains why Morningstar is using letters — instead of its celebrated star system — to grade stocks.

“We’re looking at four separate categories so it would be odd to have four different star ratings,” says Mr. Kelly. “We looked for a variant that would be understood quickly.”