morningstar stewardship grade stocks factsheet

7/29/2019 Morningstar Stewardship Grade Stocks factsheet

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Fact Sheet: The Morningstar StewardshipGrade for Stocks

Where to Find the Stewardship

Grade for Stocks

Morningstar

StockInvestorMorningstar DividendInvestor

Morningstar GrowthInvestor

Morningstar Stocks500 Book and

other Morningstar Publications

Morningstar created the Stewardship Grade or stocks to

help investors identiy and compare companies that consis-

tently align their interests with those o shareholders. The

grades reect our analysts assessment o a companys

demonstrated commitment to shareholders, and all into

our broad areas:

Transparency

Without adequate and reliable accounting practices in

place and fnancial disclosure that is truly transparent,

investors may be placed at a distinct disadvantage. As such,

our analysts evaluate a companys accounting practices

and fnancial disclosure, aiming to identiy frms that provide

investors with insufcient or potentially misleading inor-

mation. Key areas o interest include whether a frm utilizes

aggressive accounting methods, overuses one-time

charges, institutes major changes in accounting procedures

or reporting controls that may have been intended to hide

something, or ails to provide sufcient enough inormation

or investors to make an educated investment decision.

Board Independence

In theory, shareholders (who are the owners o publicly-

traded companies) delegate their control to a board o

directors that is responsible or overseeing the management

team hired to run the frm and is expected to act in thebest interests o all shareholders. In practice, many boards

all short o this objective. Our analysts take a hard look at a

companys board o directors, highlighting frms where the

chairman o the board is also the CEO, where related-party

transactions are an impediment to board independence,

or where directors lack the qualifcations or independence to

truly act in the best interests o all shareholders.

Incentives & Ownership

Investors are better served when companies align the long-

term interests o management with those o its share-

holders, primarily through the use o appropriate incentivesand required levels o ownership. Our analysts penalize

frms that lack clear goals and objectives or their compen-

sation practices, change stated goals and/or perormance

benchmarks mid-stream, or do not sufciently tie

compensation to corporate perormance. While we preer

to see managers and directors taking meaningul equity

stakes in the companies they represent, we want to make

sure that they arent giving away too much o the frm in

stock options or restricted stock.

Shareholder Friendliness

This fnal category assesses the power o shareholder

relative to management by looking at key issues like v

control, the existence o cumulative or majority voting

rights in board elections, the ability o shareholders to

ommend and/or approve changes to a companys struc

or policies, and the existence o takeover deenses or

limits on shareholders ability to protect their rights as

owners o the frm.

Morningstar stock analysts base the Stewardship Grad

public flings, previous management actions, conversa

with company ofcials, and their own expertise.

Scope

Morningstar currently has Stewardship Grades in plac

over 1,500 companies. While the extent o our coverag

uctuate rom time to time, we plan to eventually have

grades in place or all o the companies that we ollow

How Morningstar Assigns the Stewardship

Grades for Stocks

To determine each companys Stewardship Grade,

Morningstars stock analysts evaluate our broad categ

with a mixture o deductions and bonuses or dierent

types o behavior on the part o management and a copanys board o directors.

Transparency

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Does the frm engage in aggressive accounting pract

For example, has there been a major change to

accounting practices, such as revenue recognition,

the past three years that may have been intended t

hide something?

Does the company overuse one-time charges or w

os? Does it consistently disregard GAAP earnings

and point to pro orma numbers (i.e., fgures excludcharges...)? Has the frm recently changed segmen

reporting inormation in order to alter the perorma

one or more o its categories or product lines?

Has the company recently restated earnings or any

reason other than compliance with an accounting r

change? Has it recently had an unanticipated delay


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Fact Sheet: The Morningstar Stewardship Grade for Stocks

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Board Independence

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Incentives & Ownership

Shareholder Friendliness

2007. Morningstar Research Inc. All rights reserved.

in making regulatory flings or reporting quarterly results

that calls its internal controls into question?

Does the company choose not to provide a balance sheet

with its quarterly earnings release?

Bonus/Demerit: Does the companys disclosure go above

and beyond what is required and what its competitors

provide?; or, Is the company intentionally vague about its

operations or results, and operating in an environment

where disclosure and transparency is limited, making an

adequate assessment o the frms business and uture

prospects difcult?

Are the chairman o the board and the CEO the

same person?

Bonus: I the chairman and the CEO roles are combined,

does the board have a lead independent director that

can actively challenge the authority o the chairman/CEO?

While exchange listing standards and government

regulations may require boards to have a majority o

independent directors, does the board possess the inde-

pendence and qualifcations to act in shareholders bestinterests both in conducting its regular business and

during a potential crisis?

Has the board or management engaged in signifcant

related-party transactions that cast doubt on its ability to

act in shareholders best interests?

Does the company operate in an environment where

external orces (holding companies, trade unions, govern-

ments, et al) could exert undue inuence over the actions

o the board, orcing it to not always act in the best

interest o shareholders?

Has the board agreed to a compensation structure that

rewards management or being employed, rather than

or making value-enhancing decisions?

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Do the goals set out or top management by the boa

compensation committee make sense or the compa

Do they correspond to the stated long-term strategy

the frm? Is the boards disclosure o such goals suf

enough to allow you to answer the preceding quest

Has the board granted so-called retention bonuse

during a management crisis, re-defned managemen

goals mid-stream, awarded discretionary bonuses

management ailed to meet perormance benchmar

re-priced options, and/or bestowed other extraordi

perks on the management team?

Is the CEOs equity stake in the company too small t

align his or her interests with those o shareholders

the stock ownership and retention guidelines the bo

has established or top executives too lenient to ens

that management has a meaningul investment in th

longer term?

Do board members receive a majority o their

compensation in cash, rather than stock? Are the st

ownership and retention guidelines the board has

established or directors too lenient to ensure that b

members have a meaning-ul investment in the frm

longer term?

Over the past three years, has the frm given away m

than 3% o shares annually as options?

Does the company have a concentration o voting ri

that eectively prevent public shareholders rom ex

meaningul inuence?

Bonus: Is there cumulative voting (i.e., are sharehold

votes equal to shares owned times number o direct

Bonus: Does the frm allow or majority voting in

director elections? (Majority election standards ena

shareholders to vote directors out o ofce or to pre

nominees rom assuming ofce. In this sense, major

voting can be likened to a limited orm o veto).

Has a majority vote o shareholders on a proposal b

thwarted by any o the ollowing: (a) management

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Fact Sheet: The Morningstar Stewardship Grade for Stocks

2007. Morningstar Research Inc. All rights reserved.

inaction; (b) management intererence in the ballot

process; or (c) the existence o a supermajority provision?

Does the company have takeover deenses in place

that, i exercised, would signifcantly dilute existing

shareholders or avor the interests o management over

shareholders in a takeover situation?

Do the corporate governance codes and other legal

statutes o the jurisdiction in which the company is head-

quartered permit shareholders to seek regulatory action

in order to protect and enorce their ownership rights?

Bonus: Does the board and management have a sub-

stantial track record o doing right by shareholders?

Considering their track record, along with the boards and

managements disclosure, shareholder-riendliness,

and incentive structure, can they be trusted to put share-

holders interests ahead o their own in the uture?

Morningstars stock analysts will continue to ask the

hard questions when it comes to gauging how well compa-

nies adhere to the standards we have set out or them

with respect to transparency, board independence, exec-

utive compensation, shareholder riendliness, and overall

stewardship o investors capital. As regulations andgeneral corporate practices evolve, we may, however, need

to adjust our questions rom time to time in order to better

reect the changes in the environment.

Once our analysts have assessed how well a company

adheres to the standards that we have established, the

stock is assigned a letter grade rom A (best) to F (worst):

A Excellent

B Good

C Fair

D Poor

F Very Poor

All stocks are graded on an absolute basis. There is no

curve. Thereore, i a company engages in practices that a

Morningstar analyst thinks do not reect good stewardship

o investors capital, it will receive a poor grade regardless

o how other frms may have scored.

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