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Using a Value Line Report: The Benefit of High Safety Ranks in Down Markets – March 9, 2012
Value Line’s popular Timeliness Rank is located at the very top of every Value Line research report, just under the name of the company being covered. The Ranks box, which is where it is located, also contains another proprietary Value Line measure called Safety. This rank is located just below the Timeliness Rank. Although visually speaking it takes second billing, investors shouldn’t ignore this important figure.
Timeliness is about expected performance. Safety is about risk. These are two different and equally important dimensions of investing. Clearly potential performance is what most investors get excited about, but risk is what keeps people up at night. There is a balance to be had between the two.
A rank for Safety is assigned by Value Line to each of the approximately 1,700 stocks under review in The Value Line Investment Survey. This rank measures the total risk of a stock relative to the approximately 1,700 other stocks. It is derived from a stock’s Price Stability Index and the Financial Strength rating of a company, both are shown in the lower right hand corner of each report in the Ratings box. The combination of these two measures when computing the Safety rank makes the term “big picture” a particularly appropriate term here.
The Financial Strength rating is a relative measure of the financial strength of the companies reviewed by Value Line. The relative ratings range from A++ (Highest) to C (Lowest), in nine steps. They are assigned by Value Line’s team of analysts and editors based on such factors as debt load, company size, and earnings history, among others. These ratings are reviewed quarterly and changes are not made lightly.
Stock Price Stability is a relative ranking of the standard deviation of weekly percent changes in the price of a stock over the past five years. The ranks go from 100 for the most stable to 5 for the least stable. In plain English, companies with more stable share prices get a better score here. This measure is purely statistical and based on known figures.
Combining these two measures makes the Safety Rank a nice compromise between investment art and science—putting together the human world with the computer world. Safety ranks are given on a scale from 1 (Highest) to 5 (Lowest), a similar scale as used with the Timeliness Rank. Rank 1 (Highest) Safety, as a group, contains the safest, most stable, and least risky investments relative to the Value Line universe. Rank 3 (Average) Safety, as a group, is composed of stocks that are of average risk and safety. Rank 5 Safety (Lowest), as a group, consists of the riskiest and least safe stocks.
Stocks with high Safety ranks are often associated with large, financially sound companies; these same companies also often have somewhat less-than-average growth prospects because their primary markets tend to be growing slowly or, in some cases, not at all. Stocks with low Safety ranks are often associated with companies that are smaller, have weaker-than-average finances, or, in some instances, a combination of small size and weak finances. On the other hand, these smaller companies sometimes have above-average growth prospects because they start with a lower revenue and earnings base—which can often lead to higher Timeliness Ranks.
Safety becomes particularly important in periods of stock market downswings, when many investors want to try to limit their losses. The record of Safety over the years is impressive in the periods when the market is trading lower. This to say that stocks with high Safety ranks generally fall less than the market as a whole when stock prices drop.
Taking a few recent examples, between June 2008 and March 2009, Rank 1 Safety stocks, as a group, fell 32.5%, while Rank 3 stocks dropped 53.2%. While no one likes to lose money, the nearly 20-percentage-point difference between these two is material. Meanwhile, Rank 5, as a group, fell 67%--more than double the drop of the Safety Rank 1 group.
A similar pattern existed in the market drop between October 2007 and January 2008, when Rank 1 Safety stocks fell 13.3%, Rank 3 stocks dropped 19.6%, and Rank 5 stocks tumbled 25.6%. The same pattern emerged in the 2000-2001 tech meltdown and the 1987 crash. Those interested in the exact numbers can find them in our explanation all of Value Line’s proprietary the Ranks.
The goal, then is to use this tool to find compelling stocks that will provide upside potential that is commensurate with an investor’s risk tolerance. With a 1 to 5 system, it is pretty easy to achieve this. The most conservative investors should stick to stocks ranked 1 or 2 for Safety. Moderate risk investors can consider a move down into the 3s. Only aggressive investors should consider 4s and 5s. (Most investors would be better off avoiding 5s completely.)
What does this leave? Plenty of options! As of early March the following Dow 30 stocks have Safety Ranks of 1:
Safety Rank 1 and Timeliness Rank 2
Microsoft (MSFT – Free Value Line Research Report on Microsoft)
Wal-Mart Stores (WMT – Free Value Line Research Report on Wal-Mart)
Verizon Communications (VZ – Free Value Line Research Report on Verizon)
Walt Disney (DIS – Free Value Line Research Report on Disney)
International Business Machines (IBM – Free Value Line Research Report on IBM)
Intel (INTC – Free Value Line Research Report on Intel)
Home Depot (HD – Free Value Line Research Report on Home Depot)
Exxon Mobil (XOM – Free Value Line Research Report on Exxon Mobil)
Clearly each of these stocks needs further review than just showing up on the above lists, but the names here show that finding top ranked stocks for Safety and Timeliness is not, by any stretch, an impossible task.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.