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Stocks 406: Using Morningstar's Rating for Stocks

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1.
What does Morningstar prefer to use to value stocks?
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Future profits. Using future profits is easier to understand and requires less context than using ratios.
2.
The Morningstar Rating for stocks _______.
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Is analyst-driven. Morningstar estimates a company's fair value by determining how much it would pay today for all the streams of excess cash generated by the company in the future. It arrives at this value by forecasting a company's future financial performance using a detailed discounted cash-flow model that factors in projections for the company's income statement, balance sheet, and cash-flow statement. The result is an analyst-driven estimate of the stock's fair value.
3.
The Morningstar Rating for a stock can change for which of the following reasons?
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A combination of any of these factors. Any one or several of these factors can cause a change in the rating.
4.
What is a drawback of using ratios (such as price/earnings ratio or price/book ratio) to value stocks?
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They require context to understand. For example, there may be a disconnect between the ratio and the market price of the stock.
5.
Five-star stocks should generate a return _______.
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Greater than the company's cost of equity. Five-star stocks should offer investors a return that is greater than the company's cost of equity. The cost of equity is often called the "required return," because it represents the return an investor requires for taking on the risk of owning a stock. Since 5-star stocks are considerably undervalued, we expect investors will enjoy high returns that significantly exceed the risks associated with investing in the stock.