► An overview of Gradement

Example of the use of ratings

Despite all the complexity involved in the calculation of these ratings, their use is extremely simple. All the resulting values have been normalized between 0 and 10.

For example, suppose a company with the following rating values in these categories:

• Profitability rating = 8
• Solvency rating = 9
• Price fairness rating = 2

The Gradement rating

In order to facilitate the analysis, the Gradement rating unifies in a single number the value of these three fundamental ratings of profitability, solvency and price. The value of this rating has been calculated to be extremely conservative. It will only be investment grade (rating greater than 8) if all the other ratings of each of the other categories are above a certain threshold.

This way you can be sure that, by limiting your investment to high-value Gradement rating stocks, you will be investing in great companies from a quantitative point of view.

Solvency

The risk of insolvency is perhaps the factor that most drastically, and suddenly, affects the quoted stock price. You can minimize the probability of investing in companies with insolvency risk by using our solvency rating.

Using this rating you can avoid investments in companies like Eastman Kodak, that filed for bankruptcy in 2012, or General Motors, that filed for chapter 11 in 2009. Since 2009 for Kodak and 2008 for General Motors, our solvency rating for both companies indicated a value of zero. Long before it became public and evident their insolvency.

The other ratings

In addition to the four ratings described above, Gradement calculates twenty-one additional ratings per company. These ratings are modified versions of already existing state-of-the-art accounting analysis techniques in different categories:

• The industry barriers ratings are based on the Bruce Greenwald approach described in Competition Demystified.
• The solvency ratings are based in the investigations about solvency of Vicente García Martín and other professors at Malaga University. They have developed one of the most comprehensive solvency analysis framework.
• Valuation ratings (the price fairness ratings) are based on the time tested value investing framework. They compare the share price with the balance sheet, the free earnings and the free cash flow.
• The geographic rating calculations are based on the "Economic Freedom Index" published by The Heritage Foundation.
• ... (in the Guides menu you will find a brief information on the use and calculation of each rating) ...

To manually compute all these ratings for a single company requires time. Gradement automatizes this process for you.

Investor-oriented financial statements

According to GAAP/IFRS accounting standards, the financial statements must present a true and fair view of the company. These financial statements are aimed at a heterogeneous public: future investors, partners, administrators, regulators, clients, suppliers, among others.

Using this GAAP/IFRS statements as a starting point, Gradement generates four new types of financial statements specially oriented to make investment decisions. These non-standard financial statements are:

• Free cash flow statement (FCF Statement): A non standard (non GAAP/IFRS) statement that analyze the free cash available to the firm and equity.
• Balance sheet: Adjusted balance sheet with customized accounts specially designed for solvency analysis.
• Income statement: Customized and standardized accounts that clearly separate the three sources of profits for every company:
  • profits arising from its ordinary and regular activities - primary ordinary result
  • profits from secondary and non regular activities - secondary ordinary result
  • and the unusual profits - extraordinary result
• Indirect cash flow: Standard analysis of cash movements throughout the accounting period.

The free cash flow statement

Current accounting standards allow the definition of certain accounting parameters (amortization periods, provisions, cost calculations,... ) that make the net profit figure as shown in the income statement depend on certain decisions of the company directors, which opens the possibility, in exceptional cases, to accounting manipulations.

The cash flow figure is not subject to so much arbitrariness, so the free cash flow statement is a much more powerful and reliable tool for analyzing the company's earning power than the profit and loss statement.