This brief guide is an informal introduction to the use of the Gradement ratings to help the user in their investment decision making process. In other, more specific guides, you can find a more formal description of each of the ratings calculated by Gradement (you can access them either from the Guides menu or from the rating table, clicking on the rating name you want to consult).
The easiest and quickest way to decide whether to invest or maintain an investment in a particular company is to simply check the value of its Gradement rating. As with all other ratings, the Gradement rating:
The Gradement rating is a summary of the rest of the main ratings calculated by Gradement. In its simple value, from 0 to 10, are summarized ten years of accounting magnitudes, prices and financial statements and adjusted for the inflation of the currency in which the company's annual accounts are expressed.
Gradement uses the value of this rating to grade each company into five categories:
|GRADE||Gradement rating value|
|SCANT GRADE||Gradement rating between 0 and 2.5|
|POOR GRADE||Gradement rating between 2.5 and 5|
|AVERAGE GRADE||Gradement rating between 5 and 7|
|FAIR GRADE||Gradement rating between 7 and 8|
|INVESTMENT GRADE||Gradement rating between 8 and 10|
By limiting your investing to fair and investment grade companies, you will be sure to be investing in excellent companies from the accounting, economic and financial perspective. Following this strategy, you may also decide to sell when the company grade becomes average, poor or scant.
You will notice that very few companies, from the 25,000+ analyzed by Gradement, are getting today a fair grade or higher. This is mainly due to the conservative way in which Gradement calculates all its ratings. This Gradement rating value is calculated using a combination of some other ratings. Only when the rest of those ratings had high value will this Gradement rating also has a high value. A low value in any of those ratings, although the vast majority of other company ratings had a high value, will make a low-value Gradement rating.
With this conservative calculation of the Gradement rating, by requiring a high value in every other rating, we will be excluding, as possible investments, excellent companies with great potential for growth and appreciation that happens to have a low value in some particular rating. In return we have the assurance that all companies with a fair or investment grade had excellent grades in all the other major categories of which the Gradement rating is composed. This way, although not all the excellent companies from the investor point of view get a fair or investment grade, we will have the assurance that all the companies that do obtain this fair or investment grade are indeed excellent companies from the financial, economic and accounting point of view (to put it otherwise, they are not all that they are, but they are all that are).
Another reason why, nowadays, only a small percentage of companies are rated by Gradement with a fair or investment grade is because of the current level of the stock markets price overvaluation worldwide. One of the main components of the Gradement rating is the price fairness rating. This price fairness rating will have a high value only when the company is undervalued in the stock market. With prices so high today, there is little undervaluation in the stock quotations and, because of that, the price fairness rating presents a very low value in most of the companies.
We have already seen the price fairness rating. It captures the level of undervaluation or overvaluation of the stock price of a given company. A low value is an indication of overvaluation (expensive shares) and a high value is indicateve of undervaluation (cheap shares). The other two main ratings for which the Gradement rating is composed are the solvency rating and the profitability rating.
The Gradement rating includes in its calculation some other concepts but the main ones are these three: price, solvency and profitability. Those are, in our opinion, the three main axes with which to analyze every company.
Informally we can define profitability as the ability of the company to generate profits for shareholders. A company will be better the more profitable it is. But it is not enough just to look at profitability when investing. Profitability has to be qualified by two other important factors: solvency and price.
Solvency measures the ability of the company to meet its debts in a timely maner, and therefore, its ability to continue operating in the market. A low value of the solvency rating is an indication that the company has, or is expected to have in the future, difficulties in dealing with the payment of debts with third parties and so be subject to a possible bankruptcy and the corresponding liquidation/closure.
These three fundamental axes of all investment decisions, solvency price and profitability, are the ones that Gradement captures in a single value with the Gradement rating.
Another reason why very few companies are classified as fair or investment grade is because of the existent reverse relationship between solvency, price and profitability. It's not easy to find companies that simultaneously have a high value in all this three categories because:
Although the Gradement rating and its three main components: profitability, solvency and price, constitute, as we have seen, the three fundamental axes in every investment, there are another series of ratings that analyze other very important aspects of the company and that, depending on the investment style or circumstances of the user, may give to them more or less weight in his investment decision making.
We give here a very brief introduction to the meaning and use of these other ratings. Remember that in the rest of the guides you can find a more detailed explanation of each one.
All these ratings, like all Gradement's ratings, have a value ranging from 0 to 10, with 0 being the worst rating possible and 10 being the best one.
The value of this rating is an indication of the size of the company. Since there exists many ways to measure the size of a company this rating uses a combination of them, but prioritizing some with respect to others. You can consider that the company is small if the rating is less than 5. Large companies will be those with a rating of 8 or higher.
Some investors have a preference for investing in small companies because of their potential for revaluation, while others prefer large companies because of their greater stability and security in general. These investors can use this rating to filter, using the screener, those companies that they would want to analyze.
The rating can also be used to get an idea of the relative difference in size between two companies that you want to compare.
This rating measures the so-called country risk of the Government/State of the country in which the company had its headquarters. This country risk includes many factors: political risk, exchange rate and interest rates risk of the country's currency, economic risk (evolution of the country's economy), fiscal risk (taxes borne by the company and risk of State default), among others.
Since this rating is not included in the calculation of the Gradement rating, there may be companies with a high Gradement rating value but with a low value in the geographic rating. In this case the company is very good from the investor point of view but is located in a country with certain political/economic risks that can cause the rating Gradement to deteriorate in the future.
You can see this rating as an indication of the likelihood that the rating Gradement (and the other ratings) will remain at the current level in the near future. The greater the value of the rating, the greater the future stability, and therefore, the greater confidence will have to be given to the rest of ratings calculated by Gradement.
This rating measures the level of the company's indebtedness in relation to the total value of its assets that it has. The lower the value of this rating, the higher the level of indebtedness (lower financial independence of the company). It is not necessarily bad for the company to present a high level of indebtedness as long as it does not affect its solvency (the company may decide, for example, to increase its level of indebtedness to increase the financial profitability of its shareholders).
There are two versions of this rating, one that includes as business debt the so-called commercial liabilities, and other that does not include them (you can consult here a detailed explanation of the concept of commercial liability).
This rating measures the growth experienced by the company in the last seven years. There are many ways to measure growth. Gradement uses as proxy the variation of net income and free cash flow, albeit with a special emphasis on income and giving more weight to the most recent accounting periods.
Gradement automatically takes inflation into account in all its calculations (internally it uses constant monetary values). This way, we does not take into account the possible effects of an inflation increasease in the variables of income and cash flows when calculating the growth rating.
This rating measures the existing entry barriers in the company's industry. By barriers to entry we mean the difficulty that any company outside a given industry would have in grabbing market share from incumbent companies.
As a proxy for the entry barriers to a given industry Gradement uses the stability of the market share of the largest companies in that industry during the last accounting periods.
This rating will have a value above 7 for companies that pay a high dividend level. For the calculation of the rating, the dividend interest is compared with a proxy of the natural interest rate calculated by Gradement.
The rating Gradement does not include in its calculation the dividend level to appraise the value of a company, because there are more appropriate variables for that (such as the free cash flow). However, this rating is calculated because many investors consider important to analyze whether a particular company pays or not dividends, as well as the dividend interest rate offered.
This rating is a measure of the level of capital expenditure (maintenance/renovation of machinery, buildings, etc.) that the company needs to continue operating and with the same level of activity. A low rating value will be an indication that the company requires large capital expenditures (a capital intensive company) and a high value will indicate that it requires a low level of capital expenditure. All things been equal, a company with lower capital requirements will be better than another one with greater capital expenditure.
The level of capital expenditure mainly depends on the industry to which the company belongs.
For the calculation of the rating, the capital expenditure is compared to the level of assets of the company (capital needs asset-based rating) and with the company's income (capital needs revenue-based rating).
This set of ratings analyze the level of variation experienced by the following accounting variables of the company:
A high value of these ratings will indicate that the corresponding variable has not experienced large downward oscillations: either it has remained constant or has increased in value. The stediness of these values reinforces the predictive nature of the rest of the ratings. Because, in order to analyze an investment, we must necessarily rely on past accounting, the more stable the accounting variables are, the more likely the company will behave as the Gradement's ratings predict.