What is Rating and what is it for? The complete guide to understand the strategic importance of this judgment on which markets and financial investors move.
What is rating? How can we define its importance and role in finance?
The answer to these questions lies in the word trust, which is very important in a financial context.
We insist on the concept of trust because we could answer the question what is rating by defining it as a judgment on the reliability of a company.
Generally speaking, rating means both a recommendation from analysts regarding the opportunity to sell, buy or hold a stock, and an assessment of the company’s ability to repay its debts. A real risk indicator. But where does this indicator come from?
In the study of the rating it is also crucial to analyze the subjects that issue such judgments, that is the rating agencies which are even able to move the markets with their pronunciations. So let’s see what rating is, what it is for and why it is so important for the entire market.
What is rating? Definition
As already mentioned, the definition of a rating can be summarized in a judgment on the solvency, be it of a company, a bond or even an entire state. We are referring to all those subjects who borrow money from the market and who are valued on the basis of their ability to repay it and repay debts.
Those who issue these judgments are the rating agencies that allow, through their work, to draw up a real ranking on the basis of the insolvency risk linked to each subject examined. Therefore, if the rating allows us to understand how much that subject is able to honor its debts, this judgment will also be a measure of its degree of reliability on the market and will influence the strategies and fluctuations of the same securities. What the rating is and why it is so important is now beginning to be clearer.
The types of rating
Different typologies of judgments can be identified. The ones we have talked about so far are credit ratings issued on the debt of a company, which are accompanied for example by international credit ratings, national debt ratings and even the country ceiling rating. What is the difference?
- Credit Rating: it is an opinion by the agencies on the solvency of a company. Through this rating, an investor who is undecided whether to buy corporate bonds will be able to verify the issuer’s ability to repay the amount at maturity. The better the vote, the greater the attractiveness of the investment.
- International credit rating: in this case we are referring to judgments that allow us to understand the risks and costs of transferring foreign securities (therefore expressed in foreign currencies) in your own country and in your own currency.
- Rating on the debt of nations: as happens in the corporate case, a state also issues bonds. The more it will be able to repay its debts, the better the rating assigned to it by the agencies will be. Let’s take an European example: Germany is considered the most reliable country and its rating is high on the contrary instead of Italy and Greece which have much lower ratings.
- Country ceiling rating: in this case the risks and costs of an investment outside national borders are assessed. The judgment is expressed on the possible measures that a state may or may not implement to block the outflow of capital.
How is a company’s rating calculated?
The issuance of a corporate rating is an operation that requires agencies to carry out a rather detailed study, especially since these ratings are also able to influence the market itself. The first step is the economic-financial analysis, which allows you to examine the balance sheet, profitability, return on capital, cash flows, its ability to produce resources and income and a whole other series of fundamental corporate parameters.
Having examined these aspects, we move on to sector analysis, which allows the agency to make a comparison with similar companies operating in the same context. This type of analysis also allows us to highlight the future prospects of the entire market, which can obviously have repercussions on the company and therefore on the rating assigned to it.
Then we have the part dedicated to the quantitative and qualitative analysis of the company, in which the rating agencies also examine the management itself, the general management, the structure, the objectives and the choices made. Once all the necessary documentation has been obtained, and after having consulted the Central Credit Register and monitored all the movements of the company, the rating agency will be able to express its opinion in about 90 days.
The rating classes
What classes are assigned to a society, but also to a state? While it is true that ratings are assigned by rating agencies, it is equally true that each of them has its own particular yardstick and well-defined classes. In general, however, the meter used is that of the letters of the alphabet: the closer we get to the letter A, the better the rating.
Let’s consider one of the most important agencies on the market: S&P. For Standard & Poor’s the rating classes aimed at establishing the ability to repay the debt are as follows:
Note how each of these ratings can be followed by a sign - or a sign +. Both are the expression of an imminent worsening/improvement of the situation.
In the case of Moody’s the scale varies as follows:
- Aaa: minimal risk
- Aa: high quality debt
- A: good quality debt, subject to future risk
- Baa: average degree of protection
- Ba: speculative risk on debt
- B: low probability of repaying debt
- Caa / Ca: high risk investment
- C: realistic risk of insolvency
Now that we understand what a rating is and what it is used for, we must also remember that the same agency can issue two ratings on a company, one short-term and one long-term, but both express the different expectations of the agencies in about the capabilities of a company or a state.
