During our October Members Only monthly call, we acknowledged that the legacy Action Alerts PLUS portfolio ratings system had some shortcomings and that we were re-examining it. Our goal, with the help of fresh eyes, was to make the system more transparent, with clear distinctions between the categories.
On today's December Members Only monthly call, we unveiled the new AAP ratings system! While it keeps the current One, Two, Three, and Four categories, how each of those are defined and what they represent is now more in line with how we, as investors, should be thinking about portfolio positions.
With that said, here are the revised ratings categories for AAP portfolio positions:
1 - Buy Now (BN): Stocks that look compelling to buy right now.
We have high conviction in these shares. The reward-to-risk tradeoff in the stock is very attractive and there is meaningful upside potential to our price target. We are in the early to mid-stages of building out the portfolio's position in the name and the technical setup is bullish.
2 - Stockpile (SP): Positions we would add to on pullbacks or a successful test of technical support levels.
The risk-to-reward tradeoff, potential upside to our price target, or near-term uncertainty in the shares warrants a more cautious approach. We would be buyers of the shares on a pullback and would like to see a successful test or retest technical support before committing more capital to the position. Like consumers stocking up on products when they are on sale or deeply discounted, we would look to make a similar move in a Stockpile-rated position.
3 - Holding Pattern (HP): Stocks we are holding as we wait for a fresh catalyst to make our next move.
The portfolio has built out a full position in the stock and there is ample upside potential to our price target to warrant owning the shares. However, we are waiting for a fresh catalyst to emerge to determine our next step. The technical picture is neutral and the risk-reward is also neutral. We would revisit a position's Hold rating should a new catalyst - either fundamental or technical - come into play, or the shares pull back to levels offering a better risk-to-reward tradeoff. This rating is like a holding pattern one sees when traveling by air with the aircraft circling until it is given the all-clear to land or told to move to another airport.
4 - Sell (S): Positions we intend to exit.
Either the fundamental picture is eroding, or the technical outlook suggests material downside is ahead. We are looking to exit the shares and either raise cash or use some of the proceeds to fund other positions.
Recasting the AAP Portfolio With the New Ratings Categories
With the new ground rules in place, here is how we are mapping the existing portfolio into the new AAP ratings categories:
4 - Sell: None. While there are no positions tagged with this rating now, we are not averse to ranking a position a Sell should the fundamentals and technicals warrant such action.
Likely Questions and Their Answers
As we institute the new AAP ratings categories, club members will likely have some questions. In an effort to make the transition as clear as possible we've set out to answer what are likely to be some of the more common ones:
Why are you changing the AAP ratings categories?
We are establishing a more transparent, four-pronged ratings system that more closely matches how we think about managing the portfolio and its positions. Compared to the prior categories, the new ones more clearly identify the risk-to-reward proposition for each portfolio position.
What will lead you to change a rating under the new system?
Ratings upgrades and downgrades reflect changes in valuation, fundamentals, technicals, and overall risk profile in that portfolio position.
Does a new position automatically start as a One or Buy Now rating?
No. Any new addition to the portfolio is not automatically rated a One or Buy Now, rather its rating reflects the opportunity, both fundamental and technical, in the shares at the time it is being added to the portfolio.
Will you still manage the portfolio prudently, booking outsized gains when they occur?
Yes. From time to time, we will look to capture significant moves in stock positions regardless of their formal rating. Such prudent portfolio management does not mean a change in a position's rating is imminent or should be expected.