EdgeWater Research Partners LLC uses the following rating system:
For the first three years of EdgeWater's existance, I used the ratings Speculative Buy, Buy and Strong Buy, as my rating categories. I am not an industry analyst, therefore, the universe of my potential coverage essentially consists of every public stock traded. I don't use Sell ratings, for two reasons. First, I don't write short sales. I am basically an optimist so I prefer to write about things I think are going to do better , not things that I think are going to be get worse. Frankly, it might be easier and more economical to write shorts, but it is basically against my constitution so I don't. Second, when one of my stories reaches the point that I no longer feel it is appropriate to cover, which could be for any of a variety of reasons, I terminate the coverage. I don't issue a Sell rating and then hang around to see if it gets better. If I were an industry analyst, with only a handful of stocks to cover, I might have to issue Sell ratings because otherwise I would run out of things to cover when for example, the perspective industry was out of favor. But, I am not, so I don't. Besides, I often terminate coverage of stocks for reasons that I don't think necessarily constitute a Sell, in the mantra of the industry. On the same point, I don't typically issue "Hold" ratings either. I think "Hold" is another way of saying "we don't know what the heck is going on here". If I don't know what is going on with a particular stock, I will either terminate coverage because it makes me too uncomfortable, or I will take my chances and hang around thinking I will figure it out before too long, in which case I will generally tell my readers that I am not exactly sure what is going on. Like "Sells", "Hold" ratings might be convenient tools for industry analysts to use, but, again, I am not, so I don't.
As I said, I used these same ratings throughout my research, but to be honest, I never really cared for them much for a variety of reasons. Specifically, my biggest problem with these ratings is that they are a bit nondescript or perhaps lack degree. For example, if a stock is initiated with a Buy rating at $5 and a price target of $8, is it still a Buy at $7? Granted, part of the process of covering the stock is modifying the rating over time, but an analyst who still likes the stock at $7 but not as much as at $5 doesn't have a lot of places to go other than to continue calling it a Buy, which is essentially the same opinion as the stock at $5 or reduce it to a Hold, which is perhaps contrary to the way they see the stock. Secondly, at least conceptually, the term Buy is a bit more definitive than I think these rating systems mean to imply. The term Buy is pretty clear, but if you read the disclaimers attached to nearly all equity research (which most people never do) its clear that the term "Buy", really means "Buy".... if you can accept the risk of equity investments which are not guaranteed as to principal which in addition may be subject to considerable volatility "blah, blah, blah". As a result, it seems to me that the term Buy isn't really meant to apply to everyone even though it implies something different. In essence, I think if you cut to the chase, what Buy really means is better than Hold, but not as good as Strong Buy, which leads me to my current rating systems I will describe in a moment. Lastly, while this rating system appears to be a "standardized" rating system, it is really only standard in vernacular rather than practice. In other words, to one analyst, a stock with the potential to appreciate 20% over the next 12 months might be a Buy, while to others, a Buy rating is reserved for companies with a much greater appreciation potential. Therefore, it becomes incumbent upon the reader/user of the research to recognize the criteria of the writer. In other words, the standard is no longer a standard, which means that each individual provider of research might just as well use their own rating system, which could include Buys/Sells, thumbs up or thumbs down or perhaps three stars, four stars and five stars. In short, since the current rating systems provides no real benefit in terms of industry standardization, I decided to provide a rating system that is more applicable to my own approach, which includes the notion that I follow micro cap stocks, which on the face, might require different rules/standards than research regarding large cap stocks anyway.
In the past, have used the Speculative, Buy, Buy, Strong Buy ratings to delineate a 'unit" or relative amount of investment dollars I commit to my model portfolio or "coverage" list. Essentially, I used "Speculative Buy" to represent 1 investment unit (or standard dollar amount invested), "Buy" to represent 2 units and "Strong Buy" to represent 3 units. Previously I assumed 1 investment unit equaled $500. Consequently, if I started a stock at a Speculative Buy, I assumed the portfolio purchased $500 worth of the stock (1unit * $500). If I started a stock at a Buy, I assumed the portfolio purchased $1,000 worth of the stock (2 units * $500), and if I started a stock at a Strong Buy, I assumed the portfolio purchased $1,500 worth of the stock (3 units * $500). Using the same logic, if I raised a stock from a Speculative Buy to a Buy, I added an additional unit ($500) worth of the stock at that point in time at the closing price of the day I added it. Conversely, if I reduced the rating, from a Buy to a Speculative Buy, I reduced the portfolio by a commensurate number of shares equal to 1 unit at the time they were purchased, generally on a last-in-first-out basis because that corresponds the best with the chronology of the ratings changes.
All that said, my current ratings system is as follows. There are no more letters in the rating system, only numbers. The numbers range from 1 to 10, with 1 representing 1 investment unit (for my performance purposes, 1 "unit" now equals $250) and 10 representing 10 investment units or $2,500. Obviously, a rating of 10 would suggest that I favor the stock (at respective current levels) more than a stock with a rating of 1.
For those hung up on the tradition of more typical rating systems I would submit the following guidelines.
An EdgeWater rating of 1 thru 3 would best correspond to a "Speculative Buy" although I would caution that a rating in that range should not assume that the stock is necessarily more "risky" than a stock with a higher rating. It may carry a lower rating because the stock is trading closer to a price target I am unwilling to raise at that point. This by the way applies to all of my ratings.
An EdgeWater rating of 4 thru 6 might best (although not perfectly) correspond to a standard "Buy" rating.
An EdgeWater rating of 7 thru 10 would best correspond to a Strong Buy" however, ratings at the higher end of that range would indicate something that I deem as quite extraordinary..... an "Extreme Buy" if you will. You will not see a lot of these.
