Stock Ratings: What They Are and Why They Matter
The stock market is a complex system made up of complex techniques and various participants, including investors, market makers, traders, hedgers, speculators, financial experts and analysts.
Some of the most respected figures in the stock market world are analysts who spend their time researching companies.
These analysts earn a living by sharing their views and opinions on what they believe is going to happen with the company in the future.
Stock analysts research companies or specific industries, perform financial analysis based on historical data and current market trends, and create models to predict future performance.
Analysts usually convey how they feel about a stock’s future performance through a stock rating.
In this article, we will look at the different types of analyst ratings and discuss how traders can use them.
What is a stock rating?
A stock rating is a measure of a stock’s expected performance over a given period. Analysts and brokerage firms often use ratings when issuing stock recommendations to stock traders.
Analysts arrive at stock ratings after researching various companies’ public financial statements, talking to executives and customers, or listening to those companies’ conference calls.
Most analysts issue ratings four times a year at three-month intervals.
Types of Analyst Stock Ratings
Analyst stock ratings can range from simple “buy” and “sell” ratings to “equal weight” and “outperform” ratings.
Let’s take a look at the many ways analysts rate stocks.
A “buy” rating is a recommendation to buy a particular stock. This rating indicates that the analyst expects the stock price to go higher in the short or medium term and recommends that traders buy the stock.
Analysts also sometimes indicate that a stock is a “strong buy” if they believe the stock can dramatically outperform the market at large or within its sector.
A strong buy rating can be given to a stock that has current near-term catalysts, such as a return to profitability, or an attractive new product/service launch.
Strong buy ratings are usually accompanied by highly optimistic price targets on the stock, such as a 40% or 50% increase over the next five months.
A “sell” rating is when the analyst thinks the stock will underperform the market and traders should sell it.
When an analyst issues a sell rating on a stock, it means that they expect the stock to fall below its current levels in the short to medium term. It also indicates that the analyst has identified a major challenge existing in the company.
However, a sell rating is not that common and most analysts tend to give a stock a “neutral” rating, even if they believe it should be a “sell.”
A “hold” rating tells stock traders not to sell or buy more of the stock.
Analysts typically assign this rating when they believe a stock will perform in line with comparable companies in that particular sector or should perform in line with the market.
A hold rating is considered better than sell and no better than buy. This means that traders with existing long positions should not sell, but new traders with no positions should enter the market.
Analysts often issue a hold rating when there is uncertainty about a company’s quarterly financial reports, new products/services, or its direction.
Analysts may issue a hold rating if a company is still posting strong profits but is unsure whether it will meet its guidance.
An “underperform” rating means that the analyst expects the stock to perform worse than the index or the overall stock market. In other words, analysts assign an underperform rating if they expect a stock to deliver inferior returns and recommend that traders stay away from it.
For example, if a particular stock has a total return of 4% and the S&P 500 Index has a total return of 9%, the stock has underperformed the index by five percentage points.
This rating is considered bearish and is sometimes synonymous with ratings such as “weak hold,” “underweight,” and “medium sell.”
An “outperform” rating is issued when the analyst expects the benchmark index or the overall stock market to provide higher returns.
Analysts assign this rating to a stock when they expect it to outperform the index or the overall stock market.
For example, if a stock has a total return of 9%, and the S&P 500 has a total return of 6%, it outperforms the index by three percentage points.
This rating is considered a bullish rating and is sometimes synonymous with “overweight”, “moderate buy”, “accumulate” and “market outperform”.
An “equal-weight” rating means that the analyst believes the stock will be in line with the average of all stocks covered in that particular sector.
This type of rating helps traders to accurately compare stocks in a particular industry or sector with each other.
Pros and cons of using analyzers
Like many tools used to analyze financial instruments, analyst ratings can be helpful, but they also have their downsides.
For this reason, it is important for stock traders and investors to know the pros and cons of using analyst ratings.
Marks of Analysis Targets
- Data Based: Analyst ratings are usually data-driven based on carefully constructed valuation coefficients and forecasts.
- Convenient: Many financial news outlets publish analyst ratings for stocks, especially some of the most heavily traded stocks.
- Strategic: Knowing the analyst rating on a particular stock can help traders and investors analyze the risk/reward profile of owning that stock, which can help them take an informed decision before executing a trade.
Disadvantages of analyst ratings
- Incompatible: Analyst ratings change over time and are often not accurate in predicting stock movements over time.
- Inadequate when used alone: Analyst ratings alone are not sufficient to drive a trader’s decision to sell, buy or hold a particular stock. A trader has to consider other factors to decide whether a particular stock is worth holding in their portfolio.
how to use Analyst Ratings
Stock traders should be able to use analyst ratings effectively.
In this section, we’ll cover some things you can do to understand how to understand analyst reports about a particular stock and how to use them to execute your own trades.
#1: Check rating history
When you’re looking at stock ratings, check to see if analysts are suggesting upgrades, downgrades or starts for a particular stock. Check to see how the rating has changed compared to past ratings and if the analyst has announced or changed a price target.
Sometimes an analyst may give the same rating and just change the price target. This allows the stock to move in either direction, depending on the magnitude of the change between the two price targets.
#2: Check for other news
Traders also need to check to see how the stock responds to good or bad news. This will be an indication of the company’s future outlook as analyst ratings are often released after the company releases news.
#3: Look at the sector for news
Additionally, you need to see if other stocks within the sector have received similar ratings from analysts. This can indicate micro news, which occurs when a particular company or an entire sector trades a certain way because of news outside of a single company.
#4: See note
Analyst Notes provide additional insight into stocks and the ratings analysts have assigned to them. Therefore, it is important to see these notes if they are available.
The opening of an analyst note contains information on price targets and ratings. You also need to take a look at the summary of the note, which you can find in the first few pages and can give you a better understanding of the company.
Analyst notes can help traders understand how analysts arrived at their ratings on a stock.
#5: Make a decision
Once you review the analyst’s rating and determine how they arrived at it, you can make a decision based on the analyst’s review of the stock. Analyst ratings are a great indication of what market experts believe in a company or sector, allowing traders to better understand the stocks they are interested in.
Looking at analyst ratings is a popular way traders and investors use to decide whether they should buy, sell or hold a particular stock. Ratings are created by analysts who spend most of their time looking at publicly traded companies and the stock market.
Ratings can serve as a valuable tool for stock traders. However, that’s not the only thing you look at when you’re trying to make a trading decision. You should only include them as part of the puzzle.
When using stock ratings, you need to do your own thorough research on the stocks you want to trade, rather than relying on someone else to do it for you.