Stock Rating: What They Are & Why They Are Important

The stock market is a complex system made up of intricate technologies and a variety of participants, which include investors, market makers, traders, hedges, speculators, financial experts, and analysts.

Some of the most highly regarded individuals in the stock market world are analysts who spend their time researching companies.

These analysts earn a living by sharing their opinions and views on what they believe is going to happen to a company in the future.

Stock analysts research companies or specific industries, conduct financial analysis based on historical data and current market trends, and build models to forecast future performance.

Analysts usually convey how they feel about the future performance of a stock via stock ratings.

In this article, we will look at the various types of analyst ratings and discuss how traders can use them.

What is a stock rating?

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 the conference calls of those companies.

Most analysts issue ratings four times a year, at intervals of three months.

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 several ways analysts rate stocks.

Buy Rating

A “buy” rating is a recommendation to buy a particular stock. This rating indicates that an analyst expects the price of a stock to move higher in the short-term or mid-term and recommends that traders buy the stock.

Analysts may sometimes even go so far as to indicate that a stock is a “strong buy” if they believe a stock is likely to outperform the market at large or its sector.

A strong buy rating can be given to a stock that has an existing near-term catalyst, such a return to profitability, or the launch of an exciting new product/service.

Strong buy ratings are typically accompanied by extremely optimism price targets on the stock, such as a 40% or 50% gain over the coming five months.

Sell ​​Rating

A “sell” rating is when an analyst thinks a stock will underperform the market and traders should sell it.

When an analyst issues a sell rating on a stock, this means they expect the stock to fall below its current level in the short- to mid-term. It also indicates the analyst has identified a major challenge that exists at a company.

However, sell ratings are not that common and most analysts tend to give a stock a “neutral” rating, even when they believe it should be a “sell.”

Hold Rating

A “hold” rating tells stock traders not to sell a stock nor buy more of it.

Analysts usually assign this rating when they believe the stock will perform similarly to comparable companies within that specific sector or perform in a way that’s consistent with the market.

A hold rating is considered to be better than sell and not better than buy. This means that traders with existing long positions aren’t supposed to sell, but new traders with no positions should not get into the market.

Analysts often issue a hold rating when there is uncertainty in a company regarding pending quarterly financial reports, new products/services, or its direction.

Analysts can issue a hold rating even if a company is still posting strong profits but is not sure whether or not it is going to meet its guidance.

Underperform Rating

An “underperform” rating means an analyst expects a stock to produce worse returns than an index or the overall stock market. In other words, analysts assign an underperform rating if they expect a stock to produce inferior returns and recommend that traders stay away from it.

For example, if the total return of a particular stock is 4% and the total return of the S&P 500 index is 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,” “under-weight,” and “moderate sell.”

Outperform Rating

An “outperform” rating is issued when an analyst expects a stock to provide returns that exceed a benchmark index or the overall stock market.

Analysts assign this rating to a stock when they expect it to provide superior returns than an index or the overall stock market.

For example, if the total return of a stock is 9%, and the total return of the S&P 500 is 6%, it outperformed the index by three percentage points.

This rating is considered to be a bullish rating and is sometimes synonymous with “overweight,” “moderate buy,” “accumulate,” and “market outperform.”

Equal-Weight rating

An “equal-weight” rating means that an analyst believes that a stock will perform in line with the average of all the stocks that they cover in that particular sector.

This type of rating helps traders get a true comparison of stocks to each other in a particular industry or sector.

Pros & Cons of Using Analysts

As is the case with 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.

Pros of analyst targets

  • Data-driven: Analyst ratings are usually data driven, based on carefully constructed valuation multiples and forecasts.
  • Convenient: Many financial news outlets publish analyst ratings for stocks, particularly some of the most traded stocks.
  • Strategic: Knowing the rating that an analyst on a particular stock can help traders and investors analyze the risk/reward profile of owning that stock, which can help them make a wiser decision before executing a trade.

Cons of analyst ratings

  • Inconsistent: Analyst ratings tend to change every now and then and they are often not accurate in forecasting the movement of a stock over time.
  • Insufficient when used alone: Analyst ratings alone are not sufficient to drive a trader’s decision to sell, buy, or hold a particular stock. The trader has to take other factors into consideration to determine whether it is worth having a particular stock in their portfolio.

How to use analyst ratings

Stock traders should be able to use analyst ratings in an effective way.

In this section, we’ll cover a few things you can do to understand how to grasp all the details analysts report about a particular stock and how to use it to execute your own trades.

#1: Check rating history

When you are looking at stock ratings, check to see whether analysts suggest an upgrade, downgrade, or initiation for a particular stock. Check to see how the rating has changed compared to past ratings and whether the analyst has announced or changed a price target.

Sometimes an analyst can issue the same rating and only change the price target. This could make the stock to move in either direction, depending on the magnitude of the change between 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 since analyst ratings are often released after the company announces news.

#3: Look at the sector for news

Additionally, you need to check to see if other stocks within the sector have received similar ratings from analysts. This could indicate micro news, which is when a particular company or the entire sector trades in a particular way because of news outside of one company.

#4: Look at the note

Analyst notes offer additional insights into stocks and the ratings that analysts have assigned them. Therefore, it is important to look at these notes if they are available.

The beginning of an analyst note contains information on the price target and rating. You also need to take a look at the summary of the note, which you can find in the first several pages and give you a better understanding of the company.

Analyst notes can help traders understand how analysts arrived at their rating on a stock.

#5: Make a decision

Once you have reviewed an analyst’s rating and determined how they arrived at it, you can then make a decision based on the analyst’s review of stock. Analyst ratings are a great indication of what market experts believe in a company or a sector to help traders get a better understanding of the stocks they are interested in.

Bottom Line

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 that 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, they are not the only thing that you look at when you are trying to make a trading decision. you should only include them as a piece of the puzzle.

When using stock ratings, also you need to conduct your own thorough research on the stocks you want to trade instead of relying on someone else to do it for you.

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