Lehman Brothers | Global Equity Strategy

Global Equity Research

31 July 2007

Quantitative Strategy

Trading on Quality:
Our trading rule for all earnings seasons
STOCK SELECTOR

We have developed a trading rule for the earnings season: we believe companies
that have high earnings quality (as defined in this report) and deliver a positive
earnings surprise, outperform companies that have a positive surprise but low
quality of earnings.

Importantly, the market appears to adjusts slowly to this information, allowing

investors to profit from such a strategy.

Rishav Dev
(91) 22 3053 2914
rdev@lehman.com

We list the companies that currently screen as high and low quality based on our
methodology in this note in advance of the bulk of reporting dates for the current
earnings season. We suggest that if stocks on this list report a positive earnings
surprise this earnings season, that investors buy and hold the stocks for two months.

Ian Scott
(44) 20 7102 2959
iscott@lehman.com

More generally, we find that earnings quality measures can be used to enhance other
factors that we regularly use as catalysts, such as earnings momentum. We show this
in practice for a global universe.

We use a definition of quality based on accruals; while not perfect, we find that it is
readily applicable to a broad group of global companies.

Inigo Fraser Jenkins

(44) 20 7102 4658
ifraserj@lehman.com

Marketing Analyst
Jane Pearce
(44) 20 7102 1662
japearce@lehman.com
Please see our website at
https://live.lehman.com/go/keyword/eqs

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Lehman Brothers | Global Equity Strategy

1 INTRODUCTION
Are all earnings equal? And if not, are there trading opportunities as a result? These are
the two central questions that we seek to address in this paper. We think the answers are
no and yes, respectively. Importantly, the market appears to adjust slowly to the
information contained in the quality of earnings, enabling investors to profit from it.
The notion of quality of earnings has been addressed in the academic literature for
some time, and there is a growing body of work on the subject, see the seminal work by
Sloan (1996) and also Richardson, Sloan and Soliman (2001) and Chan, Chan, Jegadeesh
and Lakonishok (2001). The central question in most of this academic work has been,
how should earnings quality be measured? The focus in this note is different: can
earnings quality measures be profitably employed as trading strategies? Also, the
academic work to date has been almost exclusively US-centric, here we address a global
universe.
There is an issue of how the quality of earnings should be defined and then measured.
Following Richardson et al (2001), we use an accruals measure. The motivation for the
approach is that, broadly speaking, earnings for a company in a given year have two
components: cash flow generated that year and accruals across years. Should these two
parts of earnings be treated equally? Or more specifically, should an equal multiple be
applied to both? We show that there are indeed differences, especially relating to using
earnings momentum as a catalyst for stock returns, or earnings surprise.
We would like to be clear at the start about what we are not saying. We are not saying
that accounting does not matter. We are not free cash flow zealots who deny the
importance of earnings over and above the cash flows of a company (see section 2).
In this paper we show how an earnings quality measure can be used to augment
traditional catalyst factors such as earnings momentum. We go on to develop a trading
rule and show that in recent quarterly earnings seasons that companies that positively
surprise versus consensus that also score highly on our earnings quality measure go on to
outperform those that just have a positive earnings surprise.

31 July 2007

Lehman Brothers | Global Equity Strategy

2 ACCOUNTING MATTERS
We would like to be clear about one thing before we start on the detailed analysis of
earnings quality. We are suggesting that the accruals component of earnings can give
incremental information that is economically significant. However, we would not
subscribe to the view that is sometimes heard that cash is always better than earnings for
discriminating between stocks. The argument of the free cash flow zealots is that
earnings are prone to manipulation and that cash is a pure concept about which there
can be no dispute. The ultimate extension of this argument is that accounting does not
matter. We would strongly dispute this both in theory and with empirical evidence. True,
some accrual items that bring about differences between cash and earnings involve
assumptions or conventions that may strictly speaking reduce their accuracy. In extreme
cases it leaves some items open to manipulation by management. However, the
accounting rules are there for a good reason and accruing flows across years gives a
truer picture of the state of a company. Moreover cash flow is not exempt from
assumptions in its measurement anyway.
Even for people who do not agree with the theory on this point, we think that empirically
the results speak for themselves. Earnings strongly outperforms cash flow as a
discriminator between winners and losers. This is true at the global level, within regions
and for sectors (Figures 1-3). For example, a simple screen on P/E across a global
universe of large-cap names every quarter from 1991 to the present, rebalancing the
portfolios each quarter would have yielded a long-short return of 19.1% pa. The same
screen run on free cash flow yield would have yielded only 10.1% pa. Figure 2 shows
that this is not because of regional distortions, and Figure 3 shows that it is still true if
sectors are taken into account.
Figure 1: Performance of P/E and FCF Yield (Global Non Sector Neutral)
2500

Dec 89 = 100

2000

PE

1500
1000

FCF Yield

500
0
Dec-89

Dec-92

Dec-95

Dec-98

Dec-01

Dec-04

Chart shows the relative performance of cheap and expensive stocks screened each quarter on the measures
shown. The investment universe is the 500 largest stocks in the FTSE World index.
Source: Lehman Brothers Equity Strategy

31 July 2007

Lehman Brothers | Global Equity Strategy

Figure 2: Performance of P/E and FCF Yield (Regions, Non Sector Neutral)
800

PE Japan

Dec 89 = 100

700
600
PE Europe

500
400

PE US

FCF Yield
US

300
200

FCF Yield
Europe

100

FCF Yield Japan

0
Dec-89

Dec-92

Dec-95

Dec-98

Dec-01

Dec-04

Chart shows the relative performance of cheap and expensive stocks screened each quarter on the measures
shown within each region.
Source: Lehman Brothers Equity Strategy

Figure 3: Performance of P/E and FCF Yield, Sector Neutral (Europe)

200

Dec 91 = 100

PE

180
160
FCF Yield

140
120
100
80
Dec-91

Dec-94

Dec-97

Dec-00

Dec-03

Dec-06

Chart shows the relative performance of cheap and expensive stocks screened within each sector every quarter
on the measures shown. Universe is the 300 largest stocks in the FTSE World Europe index.
Source: Lehman Brothers Equity Strategy

31 July 2007

Lehman Brothers | Global Equity Strategy

3 OUR MEASURE OF QUALITY

The starting point for our measure of quality is to divide earnings into cash flow in the
period and accruals. What measure of cash flow should be used? We wish to focus on
the operating activity of companies rather than their financing decisions. As such, we use
a measure of free cash flow (FCF) that we define as cash flow from operations less
capex1.
Our measure of quality is therefore the proportion of earnings that comprises accruals,
i.e.

Accruals =

(netincome FCF )
netincome

Where we interpret low accruals as high quality and vice versa.

We exclude auto stocks and
Financials from this study

The definition used here is for non-Financials. Equivalent measures can be developed for
financial stocks, but we will leave that for another paper. We have also excluded auto
stocks from the analysis as the cash flows from the financing operations of some of these
companies swamps the cash flow of the core car production business within the group
accounts that we are using here.
It has been suggested that the persistence of earnings is a measure of their quality. We
have deliberately avoided such a measure here as there will be a high correlation with
whether companies are in cyclical or non-cyclical industries and the length of the cycle.

31 July 2007

Richardson et al (2001) use a broader definition of FCF. They define it as the sum of cash flow from operating
activities and cash flow from all investing activities. The main difference between that definition and the one that
we use here will be flows from the acquisitions and disposals of fixed assets. We choose to focus on capex as it
will be less quantised than these other items, and also it is the natural cash corollary of the depreciation charge
that impacts earnings.

Lehman Brothers | Global Equity Strategy

4 EARNINGS MOMENTUM AND EARNINGS QUALITY

In this note we focus not on the impact of accruals data in isolation, but rather on their
interaction with earnings momentum and earnings announcements. This is because we
think this is where the subject of earnings quality most directly affects strategies that are
implemented by investors. In this section we focus on the interaction of earnings quality
and earnings momentum, in section 5 we analyse earnings announcements.
We find that a very useful catalyst for stock performance has been earnings momentum,
which we define as the change in 12-month forward consensus forecasts between the
past two quarters. We show that the quality of earnings of these companies has a
significant impact on the efficacy of the measure. In the following sections we show the
impact when used in market-wide strategies, by region, by sector then when used as part
of an overall value + earnings momentum model.

Market-wide Earnings Momentum

Stocks that have seen a large upgrade to consensus forecasts tend to outperform those
that have had forecast cuts or increases that have not been as large. As we show here, the
size of this effect is much enhanced by using an earnings quality overlay. To do this we
used the 500 largest stocks in the FTSE World index as the starting universe. We
screened them by earnings momentum and earnings quality2 and sorted into four
quadrants as shown in Figure 4.
Figure 4: Momentum/Quality Portfolios
Earnings Momentum

High Quality
Low Momentum

Low Quality
High Momentum

Low Quality
Low Momentum

Earnings Quality

High Quality
High Momentum

Source: Lehman Brothers Equity Strategy

Portfolios were rebalanced each quarter and the common currency total return of each
group, equally weighting stocks was calculated intra quarter. The four groups have
delivered very different returns over the period since 1991. The companies that screened
as high momentum and high quality delivered the strongest performance at 12.5% pa, the
companies with low earnings momentum and low quality performed the worst at 2.9%
pa (Figure 5).
2

31 July 2007

Throughout this discussion we define earnings momentum as change in 12-month forward consensus forecasts
between the past two quarters and earnings quality as the proportion of earnings that comprises accruals (low
proportion is high quality).

Lehman Brothers | Global Equity Strategy

Figure 5: The Interaction of Earnings Momentum and Earnings Quality

700

Dec 91 = 100

High Quality
High Momentum

600

High Quality
Low Momentum

500
400

Low Quality
High Momentum

300
200
100
0
Dec-91

Low Quality
Low Momentum

Dec-94

Dec-97

Dec-00

Dec-03

Dec-06

Chart shows the performance of stocks screened on earnings quality and earnings momentum every quarter.
Universe is the 500 largest stocks in the FTSE World index. Stocks have been equally weighted and returns are on
a total return basis.
Source: Lehman Brothers Equity Strategy

What is also of interest is that within the group of companies with high momentum,
quality matters. High momentum-high quality outperformed high momentum-low
quality by 5.8% pa. In recent years, there have been two (short) sub-periods when the
outperformance was reversed: at the height of the TMT bubble in March 2000 and
September 2001-June 2003.
Figure 6: Effectiveness of Quality within High Earnings Momentum
220

Dec 91 = 100

200
180
160
140
120
100
80
60
Dec-91

Dec-94

Dec-97

Dec-00

Dec-03

Dec-06

Chart shows the relative performance of high momentum high quality and high momentum low quality stocks
screened every quarter. Universe is the 500 largest stocks in the FTSE World index. Stocks have been equally
weighted and returns are on a total return basis.
Source: Lehman Brothers Equity Strategy

31 July 2007

Lehman Brothers | Global Equity Strategy

Sectors
We applied the same technique within sectors. To do this we split the investment
universe into 10 broad non-Financial sectors and conducted the same split by these
factors within each one by ranking stocks relative to their sector peers. Even within
sectors the same result holds. Sector-neutral, high-momentum, high-quality stocks
delivered 13.0% pa, while sector-neutral, low-momentum, low-quality stocks returned
8.3% pa. There is still a spread between the returns from high-momentum, high-quality
and high-momentum, low-quality stocks; within sectors this is 1.6% pa (Figure 7).
Figure 7: The Sector-Neutral Interaction of Earnings Momentum and Earnings
Quality
700

High Quality
High Momentum

Dec 91 = 100
Low Quality
High Momentum

600
500
400

High Quality
Low Momentum

300
200

Low Quality
Low Momentum

100
0
Dec-91

Dec-94

Dec-97

Dec-00

Dec-03

Dec-06

Chart shows the performance of stocks screened within each sector on earnings quality and earnings momentum
every quarter. Universe is the 500 largest stocks in the FTSE World index. Stocks have been equally weighted and
returns are on a total return basis. Sectors have been equally weighted.
Source: Lehman Brothers Equity Strategy

31 July 2007

Lehman Brothers | Global Equity Strategy

Interaction with Value Screens

In practice, we favour an approach to stock selection in which a valuation signal is
central to the decision to over or underweight a stock, we then use mainly earnings
momentum as a catalyst factor, which we overlay on the value screen or screens. Our
favoured approach to global quantitative stock selection is to use a value and earnings
momentum within a sector-neutral framework (see Fundamental Values: A Quantitative
Approach to Stock Selection in Global Equity Markets, Lehman Quantitative Strategy
9 October 2006). There is evidence that in certain market environments, the addition of
an earnings quality measure can add value to such a process as well.
We will not go into detail on our value + momentum approach in this note. However, the
essential point is that each quarter we go long stocks that have attractive valuations and
high earnings momentum relative to their sector peers and short stocks with the opposite
characteristics. Such an approach if applied over the period 1991 to 2007 would have
yielded an annual return of 6.03% pa with an information ratio of 0.77.
Aside from this basic approach an extra constraint can be introduced that we only use the
positive earnings if the company in question has high earnings quality (i.e. has low
accrual percentage of earnings compared with other stocks in the sector). The long-short
returns from such a strategy would have been 6.73% pa with an information ratio of
0.743, Figure 8).
Figure 8: Value+Momentum and Value+Momentum+Quality Strategies Long-Short
Returns
280

Dec 91 = 100

260
240
220
200
180
160
140
120
100
80
Dec-91

Dec-94

Dec-97

Dec-00

Dec-03

Dec-06

Chart shows the performance of our favoured Global Fundamental Values long-short strategy and the same model
with an earnings quality overlay. Universe is the 500 largest stocks in the FTSE World index. Stocks have been
equally weighted and returns are on a total return basis. Sectors have been equally weighted.
Source: Lehman Brothers Equity Strategy

So the returns are not in general higher from such an approach. However, at certain
points in the cycle the addition of the earnings quality overlay does add value (and by
extension, it detracts from value at other points). In Figure 9 we show the relative return
from a value+earnings momentum+earnings quality screen relative to a value+earnings
momentum screen. This is plotted against year-on-year changes in global earnings
growth. There is a tendency for the earnings quality measure to add value in periods
when earnings growth overall is declining. This would be consistent with the hypothesis
that in periods of declining earnings growth, the market places greater value on earnings
quality.

31 July 2007

NB some of the reduction of the information ratio is because of the smaller number of stocks being selected from
the three-way sort on value, momentum and quality compared with the original value and momentum model.

Lehman Brothers | Global Equity Strategy

Figure 9: Earnings Quality Can Improve a Value + Earnings Momentum Screen in

Certain Environments
40

% (inverted)

-20
-15

30

Accruals-Adjusted Quant
Model Excess Return (RHS)

20

-10
-5

10

5
10

-10

15

-20

20

-30
-40
Jan-92

25

Global Earnings 12M Change RHS)

30
Jan-95

Jan-98

Jan-01

Jan-04

Jan-07

Chart shows the year-on-year relative performance of our favoured Global Fundamental Values long-short strategy
with an earnings quality overlay compared to the pure Global Fundamental Values approach. We also show the
year-on-year growth in earnings for the global market. Universe is the 500 largest stocks in the FTSE World index.
Stocks have been equally weighted and returns are on a total return basis. Sectors have been equally weighted.
Source: Lehman Brothers Equity Strategy

31 July 2007

10

Lehman Brothers | Global Equity Strategy

5 A TRADING RULE FOR ALL EARNINGS SEASONS

The above back tests imply that quality can be a powerful extra tool for using earnings
signals. In this section we develop this into a specific trading rule for the earnings
season.
Stocks that positively surprise on their results relative to consensus tend to outperform,
other things being equal. The problem with this is that often this is not helpful to
investors in practice as the market makes a significant part of the adjustment relatively
quickly, so unless the surprise can be forecast, it is hard to profit from the information4.
Our hypothesis is that genuine positive surprise from a company that has high-quality
earnings ought to be more valuable than surprise from a company with low-quality
earnings. Moreover, we would contend that the market is not fully aware of which
companies are high and low quality, so there ought to be a lag in the adjustment of the
stock prices to this information. If this is the case, a trading opportunity arises.
To test this we have classified stocks as high and low quality at the beginning of recent
earnings seasons. We have then split the universe of companies that subsequently
reported a positive surprise relative to the consensus into high and low quality. A strong
pattern emerges that high-quality positive surprise outperforms low-quality positive
surprise. Moreover, it is indeed the case that the excess return accrues slowly over the
months after the announcement date and is not incorporated into prices immediately.
Figure 10 shows, for a global universe, the spread of returns within the group of
companies that have delivered a positive surprise between those that were identified as
high quality before the announcement data and those that were low quality. The market
does not appear to recognise the superior quality of earnings for the group either on the
day of announcement, nor for that matter over the following week. However, one and
two months after the announcement there is a significant outperformance of 0.6% and
1.2%, respectively. Note that these numbers are not annualised and use the mean return,
though the return on the median stock is even higher.
Companies that deliver a
positive surprise relative to
consensus and also have high
earnings quality outperform
stocks that have a positive
surprise but low earnings
quality

Figure 10: Outperformance of High-Quality Positive Surprise Companies Relative to

Low-Quality Positive Surprise. US and Europe. Average of All Quarterly Reporting
Periods in 2006
1.8

1.6

Median

1.4
1.2
1.0
0.8
0.6

Mean

0.4
0.2
0.0
1 day

1 week

1 Month

2month

Chart shows the excess return of high quality positive surprise companies over low quality positive surprise
companies. We have screened stocks in the US and Europe into high and low quality based on our accruals
measure just before each earnings season, for the four quarters of 2006 earnings. Returns have been measured
from the close before the announcement date to the date shown. We have equally weighted stocks within the US
and Europe and equally weighted the two regions.
Source: Lehman Brothers Equity Strategy

31 July 2007

There is evidence that some of the surprise can be forecasted, see Zacks (1979)

11

Lehman Brothers | Global Equity Strategy

...moreover, this effect takes

place over several months
allowing a trading
opportunity.

So our trading rule is as follows. Going into an earnings season we can classify stocks as
high or low quality using reported information that is public before the announcement
date. As soon as a high-quality company announces a positive earnings surprise relative
to consensus, we would propose buying that stock and holding it for two months from
the announcement date.
The stocks that currently screen as having high earnings quality, taken from a global,
large-cap universe are shown in Figure 11. We suggest that if stocks on this list report a
positive earnings surprise, investors adopt a buy and hold strategy for two months from
the announcement date.
Exposure to regional baskets of these stocks can be gained via Lehman Brothers custom
synthetics (Bloomberg code: LBES <G0>). Please contact your sales representative or
alan.hofmeyr@lehman.com for further information on these baskets.

31 July 2007

12

Lehman Brothers | Global Equity Strategy

Figure 11: High-Quality Selection for Q2 Earnings Season with Percentage of

Earnings Accounted for by Accruals
Sectorname
CONSUMER STABLES
TELECOMS
MEDIA
CONSUMER CYCLICALS
TELECOMS
CAPITAL GOODS
CAPITAL GOODS
CONSUMER STABLES
HEALTHCARE
CAPITAL GOODS
TECHNOLOGY
CONSUMER CYCLICALS
CONSUMER STABLES
CONSUMER CYCLICALS
CONSUMER CYCLICALS
CONSUMER CYCLICALS
CONSUMER STABLES
HEALTHCARE
HEALTHCARE
HEALTHCARE
TECHNOLOGY
BASIC INDUSTRIES
CONSUMER STABLES
CONSUMER CYCLICALS
BASIC INDUSTRIES
TECHNOLOGY
CAPITAL GOODS
CONSUMER STABLES
MEDIA
MEDIA
CONSUMER CYCLICALS
HEALTHCARE
UTILITIES
ENERGY
CONSUMER CYCLICALS
CONSUMER STABLES
HEALTHCARE
MEDIA
CONSUMER CYCLICALS
CONSUMER STABLES
CONSUMER STABLES
HEALTHCARE
HEALTHCARE
HEALTHCARE
BASIC INDUSTRIES
CONSUMER STABLES
CONSUMER STABLES
HEALTHCARE
CAPITAL GOODS
ENERGY
BASIC INDUSTRIES
ENERGY
CONSUMER CYCLICALS
TECHNOLOGY
BASIC INDUSTRIES
HEALTHCARE
TECHNOLOGY
CONSUMER CYCLICALS
HEALTHCARE

Company
COLGATE-PALMOLIVE CO
AT&T INC
NEWS CORP
AUTOMATIC DATA PROCESSING
TELIASONERA AB
FANUC LTD
GENERAL DYNAMICS CORP
ANHEUSER-BUSCH COS INC
NOVARTIS AG
SCHNEIDER ELECTRIC
INTEL CORP
NIKE INC -CL B
KELLOGG CO
METRO AG
COACH INC
HENNES & MAURITZ
ALTRIA GROUP INC
ZIMMER HLDGS INC
ROCHE HLDGS AG
ROCHE HLDGS AG
YAHOO INC
MOSAIC CO
COCA-COLA CO
INDITEX
HOLCIM
NOKIA OYJ
CATERPILLAR INC
BRIT AMER TOBACCO
COMCAST CORP NEW
COMCAST CORP NEW
DEUTSCHE POST AG
MEDTRONIC INC
EDISON INTERNATIONAL
EXXON MOBIL CORP
LVMH MOET HENNESSY
L'OREAL
STRYKER CORP
DIRECTV GROUP INC
YUM BRANDS INC
KRAFT FOODS INC
HEINEKEN NV
AETNA INC
BECTON DICKINSON & CO
BRISTOL-MYERS SQUIBB CO
SHIN-ETSU CHEMICAL
SABMILLER
NESTLE SA
PFIZER INC
ITOCHU CORP
OCCIDENTAL PETROLEUM CORP
CRH
IMPERIAL OIL LTD
CANADIAN NATIONAL RAILWAY CO
SAP AG
SOUTHERN COPPER CORP
ASTELLAS PHARMA
APPLE INC
MARKS & SPENCER GP
LUXOTTICA GROUP

Accruals
0.61
0.83
1.43
2.18
2.30
3.10
3.34
3.48
3.72
3.94
4.02
4.15
4.65
5.49
6.38
6.48
7.40
7.44
7.73
7.73
9.18
9.39
10.43
10.51
10.84
11.10
11.68
12.13
12.24
12.24
13.52
14.13
14.20
14.37
15.22
16.03
16.45
16.49
16.50
16.63
17.01
17.86
17.97
18.11
18.35
18.40
18.71
19.61
19.85
19.94
20.44
20.83
20.84
20.91
21.30
21.34
21.42
21.90
21.96

Surprise Ratio (%)*

0.60
4.36

1.69

14.75
0.58
6.66

1.68
0.46
12.69
1.02
3.85

2.28
1.70

7.40

6.62
5.15
2.44

7.43

11.14

27.07
9.65

The surprise ratio shows the difference between the results published by Bloomberg News (European stocks) or
Factset (US stocks), and the median consensus expectation for either profits or income, or sales, sourced from
BloombergNews (European stocks) or IBES (US stocks), for Q2 or half-yearly results.
Companies selected from the 500 largest companies globally. Percentage accruals based on last reported
accounts. Please note that the trade ideas within this report in no way relate to the fundamental ratings applied to
stocks by Lehman Brothers equity research analysts.
Source: Lehman Brothers Equity Strategy

31 July 2007

13

Lehman Brothers | Global Equity Strategy

6 BIBLIOGRAPHY

Chan, Chan, Jegadeesh and Lakonishok (2001) Earnings Quality and Stock Returns
NBER Working Paper 2001
Ecker, Francis, Kim, Olsson and Schipper (2005) A Returns-Based Representation of
Earnings Quality, Fuqua School of Business, Duke University
Figelman, I (2007) Interaction of Stock Return Momentum with Earnings Measures,
Financial Analysts Journal 63 number 3 May/June 2007
Richardson, Sloan and Soliman (2001) Information in Accruals about the Quality of
Earnings, University of Michigan 2001
Sloan, R (1996) Do Stock Prices Fully Reflect Information in Accruals and cash Flows
about Future Earnings? The Accounting Review (July 1996)
Zacks, L (1979) EPS Forecasts Accuracy is Not Enough, Financial Analysts Journal
March/April 1979

31 July 2007

14

Lehman Brothers | Global Equity Strategy

Analyst Certification:
I, Ian Scott, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any
or all of the subject securities or issuers referred to in this report and (2) no part of my compensation was, is or will be directly
or indirectly related to the specific recommendations or views contained in this report.
FOR CURRENT IMPORTANT DISCLOSURES REGARDING COMPANIES THAT
ARE COVERED BY OUR FUNDAMENTAL ANALYSTS, PLEASE SEND A WRITTEN REQUEST TO:
LEHMAN BROTHERS CONTROL ROOM,
745 SEVENTH AVENUE, 19TH FLOOR,
NEW YORK, NY 10019
OR
REFER TO THE FIRM'S DISCLOSURE WEBSITE AT www.lehman.com/disclosures
Important Disclosures:
The analysts responsible for preparing this report have received compensation based upon various factors including the
Firm's total revenues, a portion of which is generated by investment banking activities.
Other Material Conflicts
Lehman Brothers is acting as financial advisor to AT&T in its potential acquisition of Dobson Communications.
Lehman Brothers Inc. or an affiliate is a market maker or liquidity provider in the securities of CRH Plc.
One of the analysts on the coverage team (or a member of his or her household) owns shares of the common stock of Kraft.
Guide to Lehman Brothers Equity Research Rating System
Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed
to be in the same industry sector (the sector coverage universe).
In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive,
2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent
of our rating system. Investors should carefully read the entire research report including the definitions of all ratings and not
infer its contents from ratings alone.
Stock Rating
1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe
over a 12-month investment horizon.
2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage
universe over a 12-month investment horizon.
3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe
over a 12-month investment horizon.
RS-Rating Suspended - The rating and target price have been suspended temporarily to comply with applicable regulations
and/or firm policies in certain circumstances including when Lehman Brothers is acting in an advisory capacity on a merger or
strategic transaction involving the company.
Sector View
1-Positive - sector coverage universe fundamentals are improving.
2-Neutral - sector coverage universe fundamentals are steady, neither improving nor deteriorating.
3-Negative - sector coverage universe fundamentals are deteriorating.
Distribution of Ratings:
Lehman Brothers Global Equity Research has 2048 companies under coverage.
41% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a
Buy rating. 30% of companies with this rating are investment banking clients of the Firm.
42% have been assigned a 2-Equal weight rating which, for purposes of mandatory regulatory disclosures, is classified as a
Hold rating, 40% of companies with this rating are investment banking clients of the Firm.
12% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a
Sell rating, 23% of companies with this rating are investment banking clients of the Firm.

31 July 2007

15

GLOBAL EQUITY RESEARCH

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UK07-0xxx
UK07-00xx
UK07-0402
31
July 2007

Pub Codes: 39/5068/1002

Pub Codes: 1/24/36/39/43/1002/506816