Our 9-point stock rating system has let us pick winning stocks for decades

Every time we recommend a stock in one of our investment newsletters, we display the results of our TSI Network stock rating system (Highest Quality, Above Average, Average, Extra Risk, Speculative and Start-up) next to that stock.

We award these ratings based on a point system. We award points based on nine key factors that determine a company’s ability to survive a business setback and go on to greater success when conditions improve. It has served our subscribers and clients very well for decades.

Companies with 11 or 12 points fall into the top category: Highest Quality. Those with eight to 10 points are of Above Average quality. Six or seven points means they are of Average quality; four or five points, Extra Risk; two to three points, Speculative; one or no points, Start-up.

Here are the key factors that make up our stock rating system.

1. One point for offering products or services that benefit from habitual behaviour: These include firms that sell products that consumers must buy, no matter what the economy is doing. These companies can add stability to your portfolio. Food retailers, such as Loblaw Cos. (symbol L on Toronto), a stock we analyze in our flagship advisory, The Successful Investor, are good examples of these types of firms.
2. One point for freedom from business cycles. Demand periodically dries up in “cyclical” businesses, such as resources and manufacturing. That’s why you need to diversify. Invest in utility, finance and consumer stocks, along with resources and manufacturers.
3. One point for the ability to profit from secular trends, or two points for the ability to profit from two or more secular trends: These trends outlast ordinary business booms and busts, because they reflect ongoing social change. Free trade and rising environmentalism are just two examples of secular trends.
4. One point for industry prominence—two points for industry dominance: Companies that are prominent, or dominant, in their industries are particularly well positioned to weather economic downturns and other setbacks, and fend off new competitors.
5. One point for a long-term record of profit. A company that makes money just about every year will survive a lot longer than one that makes money sporadically, if at all.
6. One point for a long-term record of dividends. A steady or rising dividend provides a sign of safety. Dividends, after all, are impossible to fake—either the company has the cash to pay dividends, or it doesn’t. Failing or fraudulent companies hardly ever pay dividends.
7. One point for an attractive balance sheet, with adequate equity and manageable debt. When bad times hit, debt-heavy companies go broke first.
8. One point for being able to serve all shareholders. Top stock picks in this area are free of heavy-handed government regulation, free of too much dependence on a single supplier and free from abuse by insiders.
9. One point for Canada-wide or U.S.-wide operations, or two points for multinational operations. Companies that are confined to one geographical area are inherently more speculative than those whose operations are more spread out.

Unlike computerized risk assessments, our ratings demand many judgment calls. But we find this system gives us a deep-seated measure that goes to the heart of a company’s staying power, and yields few unfortunate surprises..

After you use our stock rating system help you pick stocks, you should also spread your stocks over most if not all of the five main sectors.

If you diversify across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities), and stick mainly to high quality blue chip stocks—then you can be almost certain of long-term gains in excess of what you’d get with any other investment approach.

Next, you should remain vigilant and avoid or downplay stocks in the broker/media limelight.

Investors can build up unrealistic expectations when blue chip stocks spend time in that limelight. When broker/media favourites fail to live up to those expectations, they drop much further than they would have if they had been less widely followed.

Finally, you should know that “holding for the long term” usually only pays off with investments in high-quality stocks. If you buy low-quality or speculative stocks, time tends to work against you. The longer you hold them, the likelier you are to lose money. Our stock rating system puts you in a position to maximize your profits in the long term.

Do you use a stock rating system to evaluate your prospective investments? Is it different than ours? Share your experience with us in the comments.