The High-Quality Company (HQC) Scorecard for Long-Term Investors

The aim of the HQC Scorecard for Long-Term Investors I have developed is to help investors to identify companies which are attractive long-term investments in terms of risk and reward.

 

In the graphic below you can find the overview of the classification of the HQC Scorecard for Long-Term Investors. 

Classification of the HQC Scorecard

Source: The Author

The HQC Scorecard rates companies up to a maximum of 100 points. A scoring between 80% and 100% demonstrates that -according to the HQC Scorecard- the company is a very attractive long-term investment in terms of risk and reward (such as the expected compound annual rate of return). Companies with a very attractive rating tend to be more resistant, even in times of crisis, and are very attractive as long-term investments. These types of companies also tend to be more suitable to be overweighted in an investment portfolio. A scoring between 60% and 80% expresses that the company is still attractive in terms of risk and reward. Therefore, these companies are still appealing as long-term investments.  

 

A scoring between 40% and 60% means that the company is moderately attractive. That doesn’t mean that they should not be considered as investments, but in terms of risk and reward they are less attractive. This can be due to the fact that the company’s economic moat is not that as high or the company’s financial strength is lower. However, these companies can offer high growth opportunities; but they should be reviewed regularly in your investment portfolio. Some of these companies can be more vulnerable in times of economic crisis and some can have lower growth prospects.

 

A scoring between 20% and 40% expresses that the company is an unattractive long-term investment in terms of risk and reward. A scoring between 0% and 20% indicates that the company is very unattractive according to the Scorecard. An investment in these companies is usually associated with significantly higher risks. For example, these companies may not (yet) have an economic moat, may have a low financial strength, and may not yet be profitable. Nevertheless, an investment in these companies could make sense. For example, if the company offers very high growth opportunities. However, I would recommend only investing a limited proportion of your portfolio in these types of companies due to the significantly high risk and the fact that these companies require a more frequent portfolio review.

Composition of the HQC Scorecard by Categories

 

Various categories with different weightings are included in the evaluation process: There are three categories, which contribute particularly to the risk reduction of the investment (Economic Moat, Financial Strength and Profitability). These categories account for 62% of the overall rating).

 

Four categories contribute particularly to the section reward. These categories are Valuation, Innovation, Growth and the Expected Return according to my DCF Model and these categories account for 38% of the Scorecard.

 

The category Economic Moat accounts for 28% of the overall rating, the category Financial Strength for 26% and the Profitability of the company for 8%. The Valuation of the company is weighted at 10%, the Innovation Factor at 6%, the Growth Factor at 10% and the Expected Return makes up 12% of the overall rating. 

Source: The Author

The categories, which contribute to the reduction of risk (such as the Economic Moat and the Financial Strength of the company), have the highest weighting. This is due to the fact that, if the company were to go bankrupt, the rating of the other factors would then be meaningless. For this reason, my scorecard places particular emphasis on the fact that companies with strong competitive advantages and high financials strength are rated as more attractive, because these factors contribute to the fact that these companies will be able to survive in the long-term.

 

Companies that have a very high rating in the section reward (such as the expected compound annual rate of return), but do not have many risk reduction factors (for example, no Economic Moat, low Financial Strength and low Profitability), tend to receive a lower rating than companies with lower risks (which have a high Economic Moats & high Financial Strength and Profitability) and are only rated as moderately attractive in terms of reward. This can be explained by the fact that the categories that contribute to risk reduction (such as economic moat and financial strength) are given a higher weighting (62% of the overall rating) than the factors which contribute particularly to the reward section (38% of the overall rating).

 

Approximately 56% of the categories of my HQC Scorecard are based on pure (financial) data, while about 44% of the factors are based on my personal evaluation process.

Overview of the Items of the HQC Scorecard for Long-Term Investors

 

In the graphic below you can find the individual items and weighting for each category of my HQC Scorecard. A score between 0 and 5 is given (with 0 being the lowest rating and 5 the highest) for each item on the Scorecard. In the graphic below you can see the conditions that must be met for each point of every item that is rated.

Source: The Author

An Example: Apple According to the HQC Scorecard

Source: The Author

According to the HQC Scorecard, the overall score of Apple is 85 out of 100 points. Therefore, Apple can currently be classified as a very attractive long-term investment in terms of risk and reward (such as the expected compound annual rate of return). 

 

The HQC Scorecard indicates that Apple performs particularly well in the categories of Economic Moat (100 out of 100 points), Profitability (100 out of 100 points), Innovation (100 out of 100 points) and Expected Return (100 out of 100 points) (calculated as the Expected Annual Internal Rate of Return (IRR) with my DCF Model).

 

Furthermore, Apple performs well in the categories of Valuation (76 out of 100 points), Financial Strength (68 out of 100 points) and Growth (60 out of 100 points).

Limitations of the HQC Scorecard

 

Like any other model as well, the HQC Scorecard for Long-Term Investors is also subject to limitations. One of the main limitations of models is the fact that it is based on simplifications. Various assumptions were made to create the model, and changing some of the assumptions of this model, would cause the results of the Scorecard to be different.

 

Due to these limitations, I do not use the HQC Scorecard as a sole evaluation method for assessing a buy, hold or sell recommendation for a stock, but see the scorecard as an additional evaluation method and integrate the method into the analysis process of the stock I am analyzing.

 

Here you can find all currently available investment analysis.