How Our Ratings Model Works – and How It Can Enhance YOUR Returns!

Mandeep Rai

You’ve heard me talk about our Weiss Ratings Model plenty of times. But what is it really? How does it work? And most importantly, why should you care?

That’s a lot of questions, and I’ll start with the last one first. After all, you undoubtedly are most concerned with how our Ratings can help you make better, more-profitable investment decisions.

So here’s the bottom line. In a study of the highest-rated stocks in each Ratings category, these are the returns you could have earned by owning them going back to 2010:

More specifically, if you had bought the top A-rated stocks, and rebalanced them weekly for any changes, you could have turned a 10,000 portfolio into $42,880. That’s almost double the $19,453 the S&P 500 would have given you.

What’s more, you can clearly see in this chart that Ratings matter! There’s an obvious pattern where the higher the Weiss Rating, the higher the performance – and vice versa.

So that’s the proof, and for some of you, that may be all you want to know. But if you’re still with me, here is a simplified explanation on how our Model works …

It starts with a universe of approximately 12,000 stocks listed on North American exchanges. It rates each stock based on two, equally weighted models called the Reward Model and the Risk Model.

Unlike Wall Street, which favors the reward-focused approach that emphasizes high flying gains and de-emphasizes the risk of loss, we equally weight each. That produces a safer, more conservative Rating.

To be more specific, the final output of the stock model is a single rating on the standard Weiss scale of A through F. That rating, in turn, is based on sub-ratings produced by up to eight sub-indexes. Each of the indexes is assigned value points that are weighted and tallied to determine each stock’s final rating value.  The breakdown of indexes is as follows:

Reward Model

  1. Growth Index: Evaluate each stock based on key components that include growth of operations, costs, margins, earnings, and of course, cash flow metrics – in comparison to itself, its peers and other stocks in the market.  These multi-dimensional comparisons repeat for each of the following indexes.
  2. Performance Index: Screen for excess risk-adjusted return and stock price performance over short, intermediate and long-term timeframes.
  3. ROX Index: Analyze measures of business strength and quality and the ability of management to earn a return on shareholder’s capital.
  4. Dividend Index: Measure each stock by its dividend-paying ability to reward stocks with higher total return potential.
  5. Valuation Index: Assess each stock by traditional and proven valuation metrics to uncover undervalued stocks that enhance reward potential, while avoiding overvalued stocks that increase risk.

Risk Model

  1. Volatility Index: Evaluate the gain/loss performance of each stock over various timeframes compared to itself, its peers and market benchmarks to measure profit potential compared to downside risk.
  2. Solvency Index: Measure stock by traditional balance sheet quality, and ability to meet short and long-term obligations.
  3. Valuation Index: Assess each stock by traditional and proven valuation metrics to uncover undervalued stocks that enhance reward potential, while avoiding overvalued stocks that increase risk.

When all those numbers are crunched, we get a numerical rating that corresponds to an A through F Rating. This is what that scale means:

A – Excellent – The company’s stock has an excellent track record for providing strong performance with minimal risk, and it is trading at a price that represents good value relative to the company’s earnings prospects. While past performance is no guarantee of future results, we believe this stock is among the most likely to deliver superior performance relative to risk in the future. Although even the best stocks can decline in a down market, our “A” rating can generally be considered the equivalent of a “Strong Buy”.

B – Good – The company’s stock has a good track record for delivering a balance of performance and risk. While the risk-adjusted performance of any stock is subject to change, we believe that this stock is a good value, with good prospects for outperforming the market. Although even good investments can decline in a down market, our “B” rating is considered the equivalent of a “Buy”.

C – Fair – In the trade-off between performance and risk, the prospects for the company’s stock are about average based on its track record and current valuation. Thus, we feel it is neither a significantly better nor a significantly worse investment than most other common stocks. Although stocks can be driven higher or lower by general market trends, our “C” rating can generally be considered the equivalent of a “Hold”.

D – Weak – The company’s stock is an underperformer relative to other common stocks with a similar amount of risk. While the risk-adjusted performance of any common stock is subject to change, we believe that this stock represents a poor investment based on its current valuation and the company’s current financial position. Even weak stocks can rise in an up market. However, our “D” rating can generally be considered equivalent to a “Sell”.

E – Very Weak –  The prospects for the company’s stock are not good, with significant downside risks outweighing any upside potential. This opinion is based on the company’s current financial condition in combination with the stock’s historical risk adjusted performance and current valuation. While the risk-adjusted performance of any stock is subject to change, we believe this stock is a poor investment risk. Even some of the weakest stocks can rise in certain market conditions. However, our “E” rating can generally be considered the equivalent of a “Strong Sell”.

F – Bankrupt –  Our “F” rating means that the company issuing this stock is currently in bankruptcy proceedings, and that it remains under active coverage. The decision to retain bankrupt companies’ stocks under active coverage is based on factors such as data availability and quality, and is made on a discretionary basis. Typically, shareholders in a bankrupt company lose their entire investment when the company emerges from Chapter 11 reorganization or liquidates under Chapter 7. Therefore, we feel this stock has substantial downside risk for investors and very little, if any, upside potential.

So there you have it: The proof of the model’s ability to enhance your returns and the details of how it works, in that order.  You can tell why we put so much faith in our Ratings Model and consider it an indispensable tool in the art of picking stocks. After all, not all stocks are created equal … so why not give yourself an “edge” by using our stock Ratings in your daily investing lives?

Best,

Mandeep

Mandeep Rai has more than 15 years of investing experience, working as both a stock and credit analyst. At Weiss Ratings, he researches and evaluates financial and economic themes, and makes decisions on when to buy or sell specific shares for the Top Stocks Under $10 and Weiss Ratings’ Quantum Trader portfolios.