Services like StockAdvisor and Rule Breakers used to rate stocks out of 25 to measure risk. I loved this feature. Can’t find it anywhere. Was this removed?
Hi, ranman1973.
The Risk Ratings were a feature that David Gardner brought to the Rule Breakers service and his side of the Stock Advisor scorecard. When he left the advisory side of TMF to focus on the Fool Foundation, the product managers of those services decided to discontinue the Risk Ratings. You are not the only Fool who enjoyed and miss the Risk Ratings. And while I can’t predict if or when they might return, I can help you calculate your own.
Risk is Foolishly described as the chance your investment will lose value. Risk cannot be eliminated but it can be managed. David Gardner’s Risk Ratings sought not to minimize the risk a company will lose market value, but to better understand the risk that it might. The Risk Rating system presents 25 Yes/No questions any Fool can answer for a company. Many of these questions can be answered either by looking at the company’s Premium Community Profile, looking at the latest Earnings Report income statement, or by group-sourcing with your fellow Fools on the company’s Premium Community discussion board.
Simply look up the number of No answers in the Risk Ratings scale to see how the company stacks up. Here are the Risk Rating questions:
The Company
1. Is this a Large-Cap company, with a market capitalization of at least $20b?
2. Does the company have a deep moat? Would potential new competitors face high economic, technological, or regulatory barriers to entry?
3. Is the company free of direct competitors with substantially greater resources?
4. Is the company free of disruptive upstarts visibly challenging its business model?
The Business
5. Was this company profitable in the past quarter and for the full past 12 months?
6. Does the company’s business rely on recognizable branding truly valued by its buyer base?
7. Can the company operate its business in the next three years without relying on external funding?
8. Has the company diversified its buyer base so that no single customer accounts for more than 20% of revenue?
9. Is return on equity 15% or higher, indicating the company has a moat?
Financial Strength
10. Has revenue been growing at a strong and sustainable rate — 10% to 40% annually over the past three years?
11. Is operating cash flow greater than net income, showing the company isn’t just profitable on paper?
12. Is the company producing and/or growing free cash flow (FCF)?
13. Does this company have more cash than debt?
14. Is this company relatively unburdened by debt, with a net debt to EBITDA ratio under 2 (Debt/DEBIT < 2)?
The Stock
15. Does the company pass a common test of creditworthiness (Check out the Altman Z-score, which factors in profitability, leverage, liquidity, solvency, and activity to predict whether a company is more or less likely to become insolvent)?
16. Does the company pay a dividend (size doesn’t matter - the important point is that it has enough cash flow to return excess cash to shareholders)?
17. Is the stock trading for a positive price-to-earnings (P/E) multiple less than 30?
18. Does this stock have a beta under 1.3, indicating it is relatively free of volatility?
19. Does this stock have short interest of less than 15%, indicating short-sellers are generally staying away?
Foolishness
20. Does a key insider have at least a 5% stake in the company?
21. Do the top three officers have more than 15 years of combined leadership at the company?
22. Is this stock positive or high conviction in as indicated in My Stock Screener?
23. Would an intermediate-level investor find the company’s financial statements and management ownership disclosures relatively easy to sift through and understand (If you could read and understand it, could the average Fool also read and understand it)?
24. Is this company certain to be fault-free and fraud-free in all its corporate statements and deeds (There are no guarantees in investing, so this question is an automatic No.)?
25. Are you certain this company is invulnerable to external world or macroeconomic events such that you’re sure you can get all your capital back (Again, there are no guarantees when investing, so this question is an automatic No.)?
Eagle eyed Fools will note that the last two questions make it impossible for any company to get a perfect score. That is because no company is completely risk free. These last two questions simply remind you of that fact.
So what do you do with the Risk Ratings? David Gardner came up with a Crushability index, where the highest ratings are soft and fragile and the lowest ratings are tough as, well, diamonds. Every No answer to the questions above increases the sturdiness of the company. Once you have calculated your Risk Rating, look up the rating in the table below.
**Points Crushability**
------ ------------
0-2 Diamond
3-4 Vibranium
5-6 Carbon Steel
7-8 Marble
9-10 Jawbreaker
11-12 Coconut
13-14 Glass Bottle
15-16 Aluminum Can
17-18 Cardboard Box
19-20 Beach Ball
21-22 Egg
23-25 Pillow
No company is guaranteed to fail - not even Eggs or Peeps, and a Diamond isn’t immune to collapse. And if you remember your first apartment, a cardboard box can be very sturdy when you stack it right. Which is to say that the Risk Rating is not a prediction of a company’s future but an indication of possibility. Risk ratings are not a measure of potential return on investment. A more crushable company may go on to provide stellar returns over time. And a company as hard as a mysterious alloy from another universe could fail to fully leverage its super powers. The future is promised to no one.
Fuskie
Who would not make investment decisions solely on the basis of a company’s risk rating but instead believes the value of the risk rating is as another data point to consider when evaluating your conviction in a company’s long term (3-5 years or longer) business growth potential…
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