Eleven Companies That Score Poorly on Distance to Default
We highlight one of the unique inputs to Morningstar's corporate credit ratings.
One of the four main scores that drives the Morningstar Credit Rating is a quantitative statistic called Distance to Default. This measure's defining characteristic--and what makes it unique--is that it draws upon current market prices as a key input.
We incorporate a market-based measure into the Morningstar Credit Rating for one simple reason: Markets are often a leading indicator of financial distress. In many cases, the stock price will reflect deterioration in a company's credit strength well before it shows up in financial statements or in analyst forecasts. Incorporating a market-based measure of financial distress into our Morningstar Credit Rating provides checks and balances to our other, qualitative inputs. Based on our own backtesting, as well as a cottage industry of academic work, the algorithm underlying Distance to Default has proven a valuable and accurate detector of financial distress long before the more obvious symptoms become apparent.
Haywood Kelly, CFA has a position in the following securities mentioned above: TWX. Find out about Morningstar’s editorial policies.