Introducing Morningstar’s New Stewardship Rating for Stocks

In May,Morningstar Investment Research Center launched a new stewardship rating system, the Morningstar Stewardship Rating for Stocks. They have transitioned from the previous stewardship grade system, which was derived from a somewhat more quantitative measurement of corporate governance practices, to one that focuses more heavily on the quality and depth of a company’s management and board of directors in their roles as stewards of investor capital.

The new system will require their analysts to assign one of three Stewardship Ratings–exemplary, standard, or poor–based on their assessments of how each firm stacks up in regard to capital allocation decisions and stewardship of shareholder capital. They believe their stock analysts have a unique advantage in assessing and communicating a rating of this nature, given their focus on economic moats and credit quality, and they expect it to be applicable for all companies, regardless of domicile, which is something that was not fully attainable with their old system.

New Focus: Capital Allocation
The new system allows them to get right to the heart of the matter, evaluating whether management teams are good stewards of shareholder capital, rather than indirectly trying to assess management by evaluating all the individual control mechanisms that could (but may not necessarily) affect capital allocation and shareholder returns. Under the new, more holistic methodology, Morningstar equity analysts assess companies on items such as: financial leverage, investment strategy, investment timing and valuation, dividend and share buyback policies, execution, compensation, related-party transactions, and accounting practices. Since the new methodology is more holistic and doesn’t hone in on particular governance practices, it will be applicable globally, whereas the previous methodology was relevant only in the United States and Canada.

New Methodology Specifics
Under the new stewardship methodology, analysts will assign each company one of three ratings–exemplary, standard, or poor–based on their assessments of how well a management team protects shareholder interests. The default rating for all companies will be standard, with firms receiving this rating in the absence of extraordinarily good or extraordinarily bad management and/or capital allocation decision-making. They anticipate most companies will receive a standard rating.

As part of the transition, the previous stewardship grades–denoted as A, B, C, D, or F–will be replaced with one of the three new ratings–exemplary, standard, or poor–with the rating for companies that have not yet been addressed by an analyst denoted as N/A. They feel it would be inappropriate to have an automatic translation of the current letter grades into the new rating labels because the two systems are measuring two different things, with the previous system focused more heavily on corporate governance issues and the new system weighted more heavily toward management quality and stewardship of shareholder capital.

Ratings under the new methodology are now available on more than 400 companies, with supporting written analysis in the Management & Stewardship section of the company reports. Analysts will roll out the methodology to the remainder of Morningstar’s coverage universe throughout 2012. Stewardship grades assigned under the previous system will be removed from company reports, as the old grades aren’t translatable into the ratings assigned under the new methodology. Morningstar Investment Research Center users can access the Stewardship Ratings in the Analyst Research section of stock reports . The stock screener has also been updated to reflect the new rating system.

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