Clime Quality Rating (CQR)

Fortunately businesses rarely collapse overnight. Signs of weakness are generally apparent well in advance for all to see. Despite the rosy outlook touted by the media, by management and by brokers recommending you to buy a stock, a sound framework, a little effort and a disciplined approach will allow the investor to distinguish between quality stocks and those headed for trouble.

To a large extent, quality is measurable. The audited financial accounts provide our window into management decisions and actions. The accounts show the good, the bad and the ugly. They tell us all that is needed to spot a weak company that is likely to require a value destroying diluting capital injection or one that has a high probability of failure.

The Clime Quality Rating (CQR) is based on decades of academic study and measures the financial health of a company. Building on the works of numerous luminaries in the field (which focused primarily on the balance sheet), we overlayed our own views on particular metrics (notably cashflow, profitability & earnings manipulation). A total of 45 ratios are calculated twice a year to look at the performance and solvency of the business and determine the CQR.

The CQR is built on 70 elements of financial data taken from a company’s accounts. It has been designed to separate the strong from the weak, on the quality of their financial fundamentals at a point in time and over time.

Each company has a unique CQR which is calculated twice a year from their audited accounts. Within StocksInValue, valuation and research platform, CQR’s are displayed as a star rating.

Most investor’s focus their attention on earnings when they are often best served bypassing the Profit & Loss account and focusing on the cash generating ability of the business. Even if a business is reporting accounting profits, it might be losing money on a cash basis. Strong cashflow gives management the ability to invest in the operations, reduce debt, buyback shares and pay dividends. If the company is spending more than it earns on a continual basis, this is a meaningful cause for concern with the inevitable need to raise capital via debt or equity or call the administrators.

When looking for quality companies we focus on finding businesses that can self-fund and create value without excessive leverage. 

The CQR is suitable for operating businesses that make money in making, selling or providing a product or service for customers.

The CQR is not appropriate for businesses that make money in the business of money such as banks, finance companies and insurance businesses.

The risk to these businesses is not found in the P&L, Balance Sheet or Cashflow Statement. The key risk to banks is in the credit quality of their loans. If a bank fails to get just 10% of its loans repaid it will likely fail or be nationalised.

The main thing a shareholder of a bank needs to know is the likelihood of the bank getting its loans paid back. The other significant risk is a bank run, as banks all hold deposits that are largely at call and lend to borrowers for much longer terms. Banking always has this inherent risk and especially so in times of uncertainty. Banking is a business where confidence is a key solvency indicator, important but not measurable.

Interested in identifying the CQR for your stock of interest?

See which listed companies our team of analysts rank highly (and poorly).

The current as well as past CQR is available to the public in StocksInValue. A stock’s current CQR is displayed as a 0 to 5 star rating on the company valuation screen. We encourage investors to shop for companies as they would hotels, the more stars the better! Alternatively, a company’s current as well as past CQR appears as a percentage in the Ratios dashboard.

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Read more about Value Investing | Key factors when valuing a stock

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