Q:

How does Morningstar assign star ratings?

A:

Quick Answer

According to Morningstar, star ratings are assigned based on an analyst's assessment of a stock's market price compared to its estimated fair value. The star rating is also adjusted for any risk. Morningstar assigns five different star levels to stocks.

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How does Morningstar assign star ratings?
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Full Answer

Morningstar star ratings look at how attractive a specific stock appears to investors as an investment opportunity. Morningstar states that stocks that trade at a larger discount to the fair value estimate receive a higher rating than those that trade at large premiums to the fair value estimates. Stocks that are trading close to the fair value estimates are generally given a three-star rating. However, star ratings may vary slightly based on the quality of the company in question. An example of this is outlined as a high-quality business having a smaller discount requirement because analysts feel more confident in fair values and overall cash flow projections.

Because Morningstar updates its star ratings on a daily basis, a stock's star rating may change from one day to the next. While this doesn't happen on a regular basis, there are a number of reasons that Morningstar may change a stock's star rating, including a change in the stock price. Other circumstances that can result in a change of a stock's star rating include a change in the estimated fair value, a change in the risk assessment of a company or a combination of these three factors. However, Morningstar does include a small buffer between ratings to account for insignificant changes to the stock price.

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