Understanding Exceptions to Schwab Equity Ratings

Jeffrey P. Ryan
CFA, Senior Equity Researcher, Schwab Equity Ratings®, Schwab Center for Financial Research
December 23, 2008

Part 1 of 2 in a series on understanding exceptions to Schwab Equity Ratings®.

While you build your stock portfolio, we suggest that you check each stock's Schwab Equity Rating. Even after you build it, you should monitor your stocks' Ratings each week. We recommend that you consider selling a stock if its Rating falls to D or F.

But what if the Rating on one of your stocks becomes an NR, NC or NA? Or an asterisk (*) appears next to the Rating? What do those "ratings modifiers" mean? Who makes those changes and why? And what should you do when a ratings modifier appears for one of your stocks?

You can see the reason for a stock's NR or asterisk by clicking on the NR or Schwab Equity Rating letter grade. The window that appears will give the date on which the NR or asterisk was assigned, a brief explanation of the reason, and a list of steps we recommend you follow if and when one of your stocks is assigned an NR or an asterisk. In part 2 of this series, we'll discuss those steps in more detail.

For now, let's examine the meanings of those ratings modifiers, explain who assigns them and briefly state why they might be assigned.

Nonrated stocks and Ratings modifiers
Stocks lacking a Schwab Equity Rating fall into one of three categories: NR, NA or NC. In addition, a rated stock could have an asterisk associated with the Rating.

This table provides more information about the four possibilities:

Nonrated stocks and modifiers
Category	Definition	Description
NR	Not Rated	Schwab has decided not to publish a rating on this stock due to unusual or extraordinary business circumstances related to this company. Although Schwab generally does not monitor C, D and F rated stocks for unusual or extraordinary business circumstances, from time to time, a rating of NR may appear on a particular stock.
NA	Not Available	A Schwab Equity Rating is not available on this stock due to insufficient information about the stock.
NC	Not Covered	This stock is not currently in the Schwab Equity Rating universe or is prohibited from coverage for regulatory reasons.
*	Modifier— Check news	A potentially significant event has been announced for an A or B rated stock. To view the reason the asterisk was assigned, click on the rating to view the Equity Snapshot Report or check the Schwab Equity Ratings Report.

The meaning behind NA and NC
The NA and NC categories are straightforward. Schwab Equity Ratings are based on data from a variety of sources, and not every element of that data may be available for every stock. A small number of data elements are critical for the calculation of a reliable Schwab Equity Rating, and if one of those is missing, an NA will be assigned instead.

The meaning behind NC
NC stocks are not covered by Schwab Equity Ratings. Most often this is because the company's market value is below the smallest market value of the 3,000 stocks with Ratings in a given week. Certain types of firms are also excluded, generally because their financial statements are not compatible with those of companies that form the Schwab Equity Ratings universe. For example, many American Depositary Receipt (ADR) securities only report their financial statements semiannually.

That leaves the NR category and the "asterisk" ratings modifier. Notice that both involve an event of some sort.

Whether a specific event receives an asterisk or an NR depends critically on the nature and significance of that event. When a news event involves an important, significant development—one that may impair Schwab's ability to reliably rate a stock—an NR will be assigned. On the other hand, an event might not impair the reliability of a stock's rating but nonetheless represents additional information (what we call "Pertinent News") that investors should be aware of when making a decision about the stock. In those cases, the Schwab Equity Rating will be modified with an asterisk.

Who's behind the scenes?
The assessment as to whether to assign an NR or a Pertinent News asterisk is made by the Schwab Center for Financial Research.

The responsibilities include:

Scanning news sources and monitoring price and volume activity for the universe of Schwab Equity Ratings Monitored Stocks.¹ When necessary, conducting additional investigation on selected stocks to identify potential candidates for NR status.
Monitoring those stocks for which an NR has been assigned and is currently in force.
Identifying Monitored Stocks where the current Schwab Equity Rating is believed to be appropriate but where recent news has appeared—news that clients should consider before investing in this stock ("Pertinent News" stocks).
Reviewing stocks for which there has been a large change in the Schwab Equity Rating from the prior week. We define a large change as a decline of two or more letter grades, for example, from A to C, D or F. We double-check to ensure that the Rating has been calculated appropriately and assess the need for action, for example, possibly assigning an NR or an asterisk.

What sorts of events might cause a stock's Rating to be withdrawn—the more significant action? Or modified with a "Pertinent News" asterisk?

Criteria for action
Here are some examples of the kinds of events that the Schwab Center for Financial Research might consider. Although we've included a general statement about the possible effect of each type of event on the outlook for a stock, investors should understand that significant exceptions to these summaries and examples are always possible.

News or event	Possible effect on stock's outlook
Announcements about mergers, acquisitions, spin-offs or divestitures (might apply to both target and acquiring firms)	Generally positive for target firms, generally negative for acquirers
Announcement that a company will restate earlier financial statements	Varies—restatements involving fraud or deliberate misstatements are generally negative, but others oftentimes have no effect
Announcement of a significant delay in filing financial statements with the Securities & Exchange Commission (SEC)	Generally negative
News of an investigation, probe, or inquiry by a securities exchange, the SEC or another government agency	Generally negative
News of a natural disaster or similar event that has particular impact on a company or its industry	Generally negative
News of actual or potential litigation that may materially impact reported or future earning	Generally negative (but materiality is important)
Unusual insider selling activity and/or the issue of a significant number of common shares	Generally negative
Announcement of potential or actual bankruptcy or insolvency	Generally negative
Material downgrade of the company's debt by a credit rating agency	Generally negative
A significant geopolitical event that may impact the company	Generally negative
A significant change in a company's capital structure or operating activities	Varies— might be positive or negative
Announcement of a reduction in or suspension of dividend payments	Generally perceived as negative but, longer-term, might not be negative
Resignation or dismissal of the company's auditor, a disagreement with the auditor, or a qualified opinion issued by the auditor	Generally negative

Most of the events listed above don't represent good news. However, exceptions can exist to every one of these situations, so you should determine the reason for an NR or Pertinent News asterisk before taking any action.

In part 2 of this series, we'll address the question of what further research you can do if one of your stock's Schwab Equity Rating changes to NR, NC or NA, or if an asterisk appears beside the actual Rating.

As always, if you have questions or need help, please contact your Schwab consultant. If you're not yet a Schwab client but would like to learn more, a Schwab consultant can help. Call 800-435-4000 to get started.

1. "Monitored stocks" include those stocks with A or B Ratings, all stocks on Schwab’s stock lists, stocks included in research articles, widely held and recommended stocks, stocks given high risk scores by Schwab's Risk & Credit Management Department, and stocks included in the "Schwab Market Update" in the past week.

Important Disclosures

The Schwab Equity Ratings® are not personal recommendations for any particular investor. They do not take into account the financial, investment or other objectives and may not be suitable for any particular investor. Before buying, investors should consider whether the investment is suitable for themselves and their portfolio. Additionally, investors should consider any recent market or company news.

Schwab Equity Ratings are assigned to approximately 3,000 of the largest (by market capitalization) U.S.-headquartered stocks using a scale of A, B, C, D and F. Schwab's outlook is that A-rated stocks, on average, will strongly outperform, and F-rated stocks, on average, will strongly underperform the equities market over the next 12 months. Schwab Equity Ratings are not personal recommendations for any particular investor. Before buying, investors should consider whether the investment is suitable for themselves and their portfolio. Schwab Equity Ratings are generally updated weekly. Stocks can be volatile and entail risks. Schwab Equity Ratings should only constitute one component in your own research to evaluate stocks and investment opportunities.

Schwab Equity Ratings are based upon a disciplined, systematic approach that evaluates each stock on the basis of a wide variety of investment criteria from four broad categories: Fundamentals, Valuation, Momentum and Risk. This approach attempts to gauge investor expectations since stock prices tend to move in the same direction as changes in investor expectations. Stocks with low and potentially improving investor expectations tend to receive the best Schwab Equity Ratings ("A" or "B" ratings), while stocks with high and potentially falling investor expectations tend to receive the worst Schwab Equity Ratings ("D" or "F" ratings). From time to time, Schwab may update the Schwab Equity Ratings methodology.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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