Stock Analyst Ratings and What They Mean

2022-05-16 | Simpler Trading Team

Stock analyst ratings are helpful to traders and investors as they convey how professional analysts feel about the future performance of a stock. Simpler traders use several methods to consider stocks that outperform the broader market and the S&P 500 – including analyst ratings.

Even before traders bring out their technical analysis tools, the positive outlook for a stock by an analyst may have piqued the curiosity of a trader. That curiosity can cause the stock to make its way onto the charts and potentially into a trading setup. Analyst ratings are excellent for ideas and potential setups, but they are not intended to be used as a determining factor for a trade. Traders should do their research and due diligence on each asset they trade.

Analyst Ratings Provide Stock Comparison

Analysts assign the “outperform” rating to stocks, and other asset classes that analysts anticipate will have returns that exceed the market average or similarly classified stock. The outperform rating can give traders and investors a deciding factor when comparing the performance of two securities.

An outperform rating can be based on the major indexes such as the S&P 500, the Dow Jones (DJIA), or the Nasdaq. However, it can also be based on stocks within a sector or market capitalization. The outperform rating is considered a bullish rating, which indicates upward price movement. It can also be presumed to be similar to other ratings such as “moderate-buy,” “add,” or “overweight.”

The rating “outperform” means the analyst believes the company will produce a better rate of return than similar companies. Position traders and Investors looking for a positive rate of return for a stock also consider the stock price appreciation and dividends paid to shareholders.

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Most Common Analyst Ratings

Some analysts use different terms to describe their ratings, which makes it confusing to interpret what they mean. The most simple ratings to give and for traders to interpret are the ratings buy, hold, or sell. These ratings simply mean the following:

  • Buy rating – A recommendation to buy the stock.
  • Sell rating – A recommendation to sell or even short the stock.
  • Hold rating – A neutral rating means there is no reason to buy the stock. Or, there is no compelling reason to sell it if you already own it.

Some analysts prefer to use more specific terms. While other analysts feel there is little difference between a “buy” and an “outperform” rating – or a “sell” and an “underperform” rating. 

Stock Ratings by Definition 

A buy rating for a stock is a recommendation to purchase as analysts expect that stock price 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 short- to mid-term. A strong buy rating can also indicate that analysts believe the stock is in a position to surpass the return of similar stocks in the same industry, sector, or market. If a company issues upbeat guidance for earnings, this generally results in analysts seeing that as a strong buying opportunity.

A sell rating for a stock is a recommendation to sell, and analysts project the price will fall below its current level in the short- to mid-term. Analysts may have identified challenges or weaknesses with a company. 

A strong sell rating indicates analysts believe the stock price will significantly fall below its current level in the near term. This rating indicates that analysts feel traders should not even have this stock in their portfolios.

When analysts expect a stock to perform in line with the broader market, they assign a hold rating. This rating suggests that traders do not sell a stock or buy more of it as it’s at the same pace as similar stocks. Other factors such as uncertainty in a company or its guidance can result in a hold rating. 

Analysts assign the underperform rating when a stock looks to perform slightly worse than the broader market or index. This rating signals that traders should stay away from the stock. Underperform rating is sometimes synonymous with “under-weight,” “moderate sell,” and “weak-hold.”

Analysts give an outperform rating to a stock projected to provide returns higher than the broader market average or benchmark index. It can also be known as a “strong-buy,” “market outperforms,” “overweight,” “moderate-buy,” “accumulate,” or “add.” This can signal to traders and investors a stock is in an uptrend and gaining momentum. RA target price usually accompanies ratings to allow traders to consider the fair price compared to its market value.

When an analyst changes a previous recommendation, that is called an upgrade or downgrade. When this occurs, it often leads to a significant price movement. 

Analyst Rating Averages

Some aggregate stock analyst ratings often give stocks a single score that can range from one to five. These rating systems use numbers rather than potentially confusing terminology. 

When these ratings are aggregated into a single score on a scale of one to five: 

Common Stock Analyst

Most analysts indicate a “buy” or “strong-buy” rating if the average rating is one. If the average rating is close to five, most analysts rate the stock as a sell.

Ratings are Analyst Opinions

A standard method used by all analysts to rate stocks does not exist. Analysts spend a substantial amount of time attending industry conferences, meeting investors, and visiting their company facilities. They spot trends, find problems, and often get a sense, or vibe, from meeting the company and its management.

While analysts make their assessments based on technical and fundamentals, their performance and reputation are based on how stocks perform after an assigned rating. It’s fair to say that analysts want to make good calls on stocks and assets as this can establish their careers.

Analysts who make a big call that was unexpected can rest in the accolades that accompany being right when everyone else was wrong. For that reason, an analyst will often be deemed more credible after making a big call on a sudden move by a stock.

The tools analysts use to arrive at stock ratings are the public financial statements of companies, conversations with executives and customers, and conference calls made available to investors by the companies. Most analysts issue ratings four times a year and at intervals of three months.

Technical Analysis: The Trader’s Vantage Point

There are generally two different approaches to technical analysis: the top-down approach and the bottom-up approach.

Bottom-up Approach

Position traders and long-term investors benefit from a bottom-up approach of technical analysis which focuses on individual stocks as opposed to a macroeconomic view. The bottom-up approach focuses on individual stocks as opposed to a macroeconomic – or big picture – view.

Position traders are trend followers. They analyze a stock that appears fundamentally interesting for potential entry and exit points. Should they find an undervalued stock in a downtrend, position traders could use technical analysis to identify a specific entry point when the stock could be bottoming out.

Top-down Approach

Day and swing traders will take a top-down approach. These traders would first focus on economies, sectors, stocks, and short-term gains instead of long-term valuations. These traders may be interested in a stock that broke out from its 50-day moving average as a buying opportunity.

Traders attempt to gain an edge in the markets by making informed decisions which entail evaluating historical and current data. They use two basic types of stock analysis – fundamental analysis and technical analysis.

Fundamental analysis concentrates on data from sources, including financial records, economic reports, company assets, and market share. These analysts typically analyze a company’s financial statements – balance sheet, income statement, cash flow statement, and footnotes. 

Technical analysis focuses on studying past and present price actions to predict the probability of future price movements. Traders and analysts analyze the financial market and are more concerned with price and volume.

Charts are a vital tool for technical analysts as they can provide a graphical measurement of a stock trend. Using a chart, a technical analyst may notate areas of support or resistance levels. The support levels are marked by previous lows below the current trading price, and the resistance markers are placed in prior highs above the stock’s current market price. A break below the support level would indicate a bearish trend to the stock analyst, while a break above the resistance level would take on a bullish outlook.

Technical stock analysis is practical only when supply and demand forces influence the price trend analyzed. When outside factors are involved in a price movement, analyzing stocks using technical analysis may not be successful.

Despite stock analysts having ample opportunity to be wrong, they still provide a valuable service to institutional investors and retail traders who use their ratings and reports to make investment decisions. Stock analysts’ ratings and price targets often lead to significant price movements in individual stocks. This is potentially one reason traders should pay attention to analyst recommendations even if they do not follow them. 

Can Traders Rely on Analyst Ratings?

Stock Analysts are wrong quite often, and recommendations should be taken cautiously. Traders should rely on the technical aspect they know and have in their trading toolbox to determine whether they should enter a trade. Media reports about analyst ratings often create fear in the market, which can influence the need to react within the market. 

Sometimes analysts may even have a conflict of interest should the firms they work for have stock positions. Traders should not buy or sell stocks based only on what stock analysts say. A good trading strategy should be consistent and objective. It should also outline the specific assets – or watchlist – to trade that consider risk tolerance, time horizon, and overall goals. Traders must do their own research and reach their conclusions as they think about both the technical analysis of the stock and the market in which it trades. 

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FAQs on Stock Analyst Ratings

Q: What does “outperform” mean in stocks?

A: “Outperform” is an investment rating that indicates analysts expect a stock to provide returns that exceed a benchmark index or other market average. An outperform rating is considered to be bullish.

Q: What does oversold stock mean?

A: An oversold stock is a stock that has seen heavy selling and has sunk below key support levels and traders and investors think the stock is now trading below the stock’s actual value. This can lead to buying because the stock is underpriced.

Q: What do stock analysts do?

A: Stock analysts do extensive research on individual companies and recommend buying, selling, or holding stocks. Analysts also provide 12-month price targets with revenue and Earnings Per Share projections. While analyst recommendations should be viewed cautiously, they can provide insight into companies whose stocks are sold on the U.S. stock market.

Q: What are the most basic terms that analysts use to recommend stocks?

A: The different analyst rating terms can fit into five general categories:

  1. Buy – This is sometimes called a “strong buy,” is bullish, and implies strong performance.
  2. Outperform – Also referred to as “overweight” or a “moderate-buy.” Outperform is a mild buy rating. This implies potentially higher returns than the broader stock market.
  3. Hold – This is a neutral rating called “market perform” or “equal weight.” This rating implies no reason to buy the stock but no reason to sell it if you already have it.
  4. Underperform – Also “underweight” or “moderate sell,” this is a rating that implies the stock is likely to perform slightly worse than the broader market.
  5. Sell – This infers a “strong sell” rating. A sell rating is usually given if the analyst is highly bearish and implies the stock should be sold or shorted.

Q: What does a higher stock rating mean?

A: A higher rating simply means that analysts believe the stock price will outperform similar companies.

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