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The Rating System in Motley Fool Stock Reports

By Jeff Fischer (TMF Jeff)

Every company covered by The Motley Fool's new stock research service is ranked on key criteria in each report that we issue. We offer our subjective rating system in order to help you in your evaluation and investment decisions regarding the companies being analyzed. The five criteria that we rate for each company are Industry Attractiveness, Position in Industry, Business Quality, Investment Predictability, and Overall Prospects. To each criterion, we award one to four jester caps, with four being highest.

Let's explain each criterion.

Industry Attractiveness
This first Foolish criterion measures the attractiveness of the industry in which a company operates. An industry's potential, its challenges, and its characteristics, including the quality of its sales (for example, how high are average gross profits on every dollar of revenue for the industry?) all figure in our rating of this criterion. This criterion is rated one to four jester caps based on an industry's long-term growth potential, its viability, its average or potential profitability, the ability for a company in the industry to expand its business, and so forth. You want to invest in companies that, above all, operate in extremely attractive and, if not profitable, then soon-to-be-profitable, growing industries. This criterion helps you to determine which companies are in the most promising industries for investors.

Position in Industry
Once you've found an attractive industry in which to invest, the next important step is to find a company that is very well positioned within that industry. This rating helps you to weed out the third-tier players in an industry, because Position in Industry measures where a company stands in its industry. As Fools, we typically like to invest in only the leading one or two top companies in an industry, nothing less. Is it the top dog, leading the pack (with the highest sales growth, market share, mindshare, and so forth)? Or is it a mere follower? Only true industry leaders (if not outright dominators) are granted the highest rating.

Business Quality
Once you've found a strong industry and a leading company in that industry, you still need to make certain that the company has a high-quality business. Our Business Quality rating addresses the economics and management behind a business, including its profitability, its growth avenues and future opportunities; its competitive position; its management's experience, expertise, and history; and much more. How profitable can a business become? What is the potential long-term return on investment for the business? Can the assets of the business eventually be leveraged into new growth opportunities? Does the company have sustainable competitive advantages? Business quality is arguably much more important than valuation concerns for a long-term investor. The quality of a business drives the cash flow-generating capacity, which ultimately controls the stock price. This rating (and our report's coinciding analysis) helps you to spot and learn about the highest-quality businesses listed on the stock market.

Investment Predictability
Investment Predictability takes into account the stability of a business in order to help you determine the risk that you may, or may not, face. Older, mature businesses with steady, predictable streams of cash flow (specifically, operating and net earnings) will be rated much higher in predictability than will young, sporadic, and volatile companies, the future earnings of which are difficult to predict, thereby increasing your risks. Investment Predictability essentially encapsulates all the qualities presented in our first three Foolish criteria, and then tells us how likely it is that a certain investment outcome will occur.

Overall Prospects
Probably the most self-explanatory of our Foolish criteria, Overall Prospects wraps up the whole enchilada, from industry attractiveness to a company's business quality and competitive position, from management to a company's valuation on the stock market. All of this and more combines to create an Overall Prospects rating for the company. Essentially, the conclusion derived from the full report on the company goes into this final rating. The higher the rating, the more attractive we believe the investment.

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