Stock Analyst Ratings
A stock rating is a measure of the expected performance of a stock in a given time period. Analysts and brokerage firms often use ratings when issuing stock recommendations to stock traders.
Analysts arrive at stock ratings after researching public financial statements of various companies, talking to executives and customers, or listening in on the conference calls of those companies.
Most analysts issue ratings four times a year, at intervals of three months.
Ratings are usually accompanied with a target price to helps traders understand a stock’s fair price compared to its market value.
In this article, we will explain the meaning of buy, outperform, hold, sell, and underperform ratings and show how knowledge of each rating can help stock traders to make the right investment decisions.
Types of stock ratings
A buy rating is a recommendation to purchase a specific stock. This rating implies that analysts expect the price of a stock to move higher in the short- to mid-term.
A strong buy rating means that analysts believe that a stock will drastically move above its current level in the short- to mid-term.
The analysts are usually of the opinion that the stock is poised to surpass the return of similar stocks in the same industry or sector and/or the average market return because of an existing near-term catalyst, such as the launch of an exciting new product/service, or a return to profitability.
Additionally, if a company issues an upbeat guidance for earnings, analysts are likely to see that as a strong buying opportunity.
In most cases, strong buy ratings are often accompanied by extremely optimistic price targets on the stock, such as a 40% to 50% gain over the coming 10 months.
A sell rating is a recommendation to sell a specific stock. This rating means that analysts project the price of a stock will fall below its current level in the short- to mid-term. It also implies that analysts have identified major challenges that exist at a company.
A strong sell rating means that analysts believe the price of a given stock will significantly fall below its current level in the near term. Not only are strong sell rating bearish recommendations, but they are also associated with stocks that analysts feel traders ought not to have in their portfolios.
However, it is quite rare to see publicly-traded companies receiving strong sell ratings from big investment banks such as J.P. Morgan (NYSE: JPM) and Citi (NYSE: C).
If an investment bank assigns a stock a strong sell rating, the bank is likely to face the wrath of that of particular company and could end up losing vital business (advisory roles, raising money, etc) from the company.
Moreover, a company is likely to block an investment bank that is negative about its stock from accessing its information and contacting its executives.
When an analyst gives a stock a hold rating, they expect it to perform in-line with the market and at the same pace as similar stocks. This rating technically tells stock brokers not to sell a stock nor buy more of it.
A hold rating is often assigned when there is uncertainty in a company regarding new products/services, its direction or pending quarterly report cards.
If a company is not sure whether or not it is going to meet its guidance, even if it is still posting respectable profits, that could cause analysts to issue a hold rating.
An underperform rating means that the stock of a particular company is destined to do slightly worse than the market average or a benchmark index. Therefore, analysts are recommending that traders stay away from the stock.
Underperform rating is sometimes synonymous with “under-weight”, “moderate sell,” and “weak hold”.
Analysts often base it on stocks within a specific sector (healthcare, financials etc.) or those sharing same characteristics like market capitalization (mid-cap, small cap, large cap). They can also base it on a stock index, such as the Dow Jones Industrial Average (DJIA) or the Nasdaq Composite.
For example, if a stock’s total return is 7% and the Dow Jones Industrial Average’s total return is 9%, it underperformed the index by 2%.
A stock could be expected to underperform the market if the company’s growth has slugged more than forecast during the previous quarter, thus causing analysts to believe that trend is likely continue in the future.
Companies carrying bigger debt load than peers are also likely to be rated underperform as those debts could hurt profit margins particularly hard.
An outperform rating is assigned to a stock that is projected to provide returns that are higher than the market average or a benchmark index.
For example, if a stock’s total return is 10% and the Dow Jones Industrial Average’s total return is 6%, it outperformed the index by 4%.
Also known as “market outperform”, “overweight”, “moderate buy”, “accumulate”, or “add”, this rating signals an uptrend gaining momentum. Investors generally view this rating as a strong indicator that the rated stock is a good buying opportunity. It is even used in place of strong buy by some brokers and analysts.
A stock could be rated outperform if the company posts faster than anticipated profits/revenue growth, or if it is in a sector or an industry that is under pressure because market conditions.
Ratings convey what analysts feel about a particular stock. Analysts use a lot of effort and time to analyze a stock and arrive at a rating.
That means that ratings are the result of objective and reasoned analysis of stocks by experienced professionals. Ratings, therefore, serve as a valuable tool for stock traders.
However, traders still need do their own due diligence as stock ratings are obviously a starting point and far from fail-proof.