What are Stock Analyst Ratings?
A stock analyst rating is an opinion assigned to a publicly-traded company’s stock, which indicates a financial analyst’s expectation of a future increase or decrease in a stock’s price. Typically a rating indicates Buy, Sell, Overweight, Underweight, Hold, or other derivatives of the meaning.
Prepared by a financial analyst, stock ratings are usually derived by a methodical analysis of the various factors that impact a company’s business, such as revenue, sales, competition, barriers to new market entrants, and profitability.
The purpose of analysts’ ratings is to communicate a research company’s opinion on a particular stock; investors and fund managers then use this advice to inform their investing decisions.
To create a rating, an analyst evaluates a stock and prepares a short description that emphasizes certain aspects of the issue.
What is a Stock Analyst?
A Stock Analyst, also known as a Financial Analyst, or Technical Analyst, is a professional who analyzes securities and equities to assess their eligibility for inclusion into an investment portfolio. A major part of an analyst’s job is to offer opinions and make recommendations about individual equities.
Analysts’ ratings are an attempt to make financial analysis easy to access, read, and use. Unfortunately, analyst ratings are often confusing because they are full of jargon, acronyms, and technical terms.
Even though they are popular, analysts’ ratings are just opinions. Smart investors use analysts’ ratings as a reference and read several ratings before making any investment decision.
Stock Analyst Ratings Explained
The most confusing aspect of stock analyst ratings is the terminology. Many people ignore ratings because they cannot understand the terms. The first step to using the ratings is to understand the terms the analysts use. To help you better understand stock analysts’ ratings, we will decipher some of the terms they use.
What is a Buy Rating in Stocks?
A buy rating is an analyst’s recommendation to buy a stock. Analysts will issue a buy rating when a stock displays certain criteria. Value analysts will recommend a stock if it falls to a certain price, for instance. Growth analysts will issue a buy rating if a stock’s share price doubles and looks to rise higher.
Some analysts will use euphemisms such as “strong-buy” and “on the recommended list” instead of the term buy rating. The financial media will publicize buy ratings from well-known analysts or major financial institutions.
What does an Overweight Stock Rating Mean?
The term overweight usually means an analyst believes a stock is underpriced in comparison to a benchmark index. This term is confusing because overweight means the analyst thinks the stock deserves a higher price.
Analysts usually base overweight ratings on comparison to benchmark indexes such as the S&P 500. The term weight comes from the practice of trying to determine how much of an index a stock should compose. An analyst could say that Apple (AAPL) is overweight when compared to the S&P 500 or the FAANG index.
The analyst hopes that an overweight stock will perform better than expected. Many analysts assume overweight stocks will outperform an index.
What does an Underweight Stock Rating Mean?
An underweight rating shows an analyst believes a stock’s price will underperform a benchmark index. An analyst who believes that NVIDIA’s (NVDA) share price will fall as the S&P 500 rises will say NVIDIA is underweight. The analyst says NVIDIA is underweight because she thinks it will make up less of the index in the future.
What does an Equal Weight Stock Rating Mean?
An equal stock rating means the analyst thinks a stock’s price performance will match the benchmark index. An analyst will say Ford (F) is equal-weighted if she thinks its price will grow as fast as the average stock in the S&P 500. The analyst will label Ford underweight or overweight if it grows faster or slower than the S&P 500.
What does an Underperform Stock Rating Mean?
An underperform stock rating means that the analyst thinks the stock’s performance will fall below that of the market, index, or sector.
The difference between underperforming and underweight is that underweight usually refers just to share prices. Underperform can refer to price, but it can also refer to metrics such as income, revenue, dividend, growth, and cash flow.
An underperforming stock rating usually means a stock’s performance does not meet analysts’ expectations. A retailer can underperform if its’ revenues are below those of close competitors, for example.
Other terms for underperform; include weak hold, moderate sell, and underweight. An analyst will put an underweight rating on a stock because they think its performance will fall in the future.
What does an Outperform Stock Rating Mean?
An outperform-stock rating means an analyst thinks a stock will outperform the market. An analyst could rate a stock with a return that is 5% higher than the S&P 500 as outperform. Outperform can refer to a stock’s price or its performance.
An analyst will give a tech company an outperform rating if she thinks its revenues will grow faster than the rest of the sector.
Euphemisms for outperform include accumulate, overweight, and moderate, buy. A good way to think of an outperform rating is that a stock’s performance could improve in the future. Some analysts use the term outperformer to describe these stocks.
What is a Neutral Stock Rating?
A neutral rating means an analyst thinks you need to hold the stock. Neutral means the stock will not improve, but it will not lose money. A neutral rating means the analyst thinks there will be major no changes to the stock. The analyst thinks the stock’s price will not rise or fall, and the financial numbers will not change.
Analysts usually intend a neutral rating as a recommendation to do nothing with a stock or hold it. Analysts sometimes use the term neutral rating as a euphemism for hold.
The term neutral stock rating can also mean an analyst has no opinion about a stock.
What is a Hold Stock Rating?
A hold rating means the analyst thinks the stock will retain value, but its price or performance will not increase. The hold rating shows that the analyst thinks investors need to hold a stock to make money.
In a hold rating, the analyst recommends the investor keep the stock until there is a significant change. Many analysts and financial advisers will recommend investors hold value stocks.
A neutral stock rating can refer to a hold rating. A neutral rating can also indicate an analyst has no opinion about a stock.
What does a Sell Stock Rating Mean?
The sell rating means the analyst thinks investors need to sell the stock immediately. A sell rating usually means the analyst suspects the stock price is about to collapse. Some analysts will issue sell ratings for any underweight or under-performing stock.
What does a Strong Sell Stock Rating Mean?
Some analysts will use the term strong sell. A strong sell stock rating means the analyst thinks the investor will lose money on the stock soon. The difference between the strong sell and sell is that strong sell means you need to dump the stock now. Sell means that you need to reevaluate your position in that stock.
What does a Strong Buy Stock Rating Mean?
A strong buy rating usually means the analyst thinks the stock’s returns will grow dramatically soon. BB&T Capital Markets’ analysts use the term strong buy for stocks they expect to deliver a return of 25% or higher, for example.
The difference between a strong buy and a buy is that the analyst thinks you need to consider purchasing a buy stock. A strong is a stock the analyst thinks you need to buy now if you want to make money.
What does a Long-Term Buy Stock Rating Mean?
The long-term buy rating indicates an analyst thinks the stock will steadily gain value for the foreseeable future. BB&T Capital Markets analysts describe stocks as long-term buys if they think the equities will deliver a 10% to 25% return.
Many analysts will issue long-term buy ratings for stocks they expect to deliver steady returns for the foreseeable future.
What does an Accumulate Stock Rating Mean?
Some analysts will use the term accumulate to describe a long-term buy. Barrington Research analysts use accumulate to describe stocks they think will outperform the market for over 12 months.
What does a Market Perform Stock Rating Mean?
Market Perform means an analyst thinks a stocks’ performance will match the market’s performance for the near future. Some analysts use the term market performance as a euphemism for underweight or underperforming stocks.
What does a Market Underperform Stock Rating Mean?
Market Underperformance means an analyst thinks a stock’s performance will not match the market’s performance.
What does a Peer Perform Stock Rating?
The term peer perform describes a stock that meets analysts’ expectations. A stock that meets most analysts’ expectations is often described as a peer performer.
Marketwatch attributes the term peer perform to the defunct American investment bank Bear Stearns.
This rating means an analyst thinks a stock’s performance will fall soon. The analyst thinks the stock could recover at some point in their future.
This rating shows the analyst thinks a stock will underperform for years to come. Some analysts will issue this rating if they think a stock has a low margin of safety.
How good are the Morningstar Stock Ratings?
The stock ratings from the American financial services company Morningstar (NASDAQ: MORN) are among the most popular. Morningstar’s ratings are popular because the company uses a simple five-star rating system that is easy to understand. Morningstar’s analysts consider a stock with five stars a good value at its current price. The five-star rating is a strong buy rating at Morningstar.
Morningstar’s analysts consider a one-star stock a poor value at its current price. A two-star stock is a better value at its current price. A three-star stock is a fair value at its current price. A four star-stock is a moderate buy rating at Morningstar.
One reason people use Morningstar’s Stock Ratings is that Morningstar updates its ratings daily. That makes Morningstar’s ratings some of the most up-to-date.
Another reason Morningstar Ratings are popular is that Morningstar lists stocks by sector. Another helpful feature at Morningstar is the listing of business risk. Morningstar ranks stocks Below Average, Above Average, and Average.
Business Risk is the term Morningstar Analysts use to describe Margin of Safety. Above Average shows a high margin of safety, and below-average indicates a low margin of safety.
Are Stock Analyst Ratings Accurate?
Our research has shown that Analyst Ratings are often inaccurate and heavily weighted to Buy or Strong Buy recommendations. When it comes to predicting falling stock prices, Analyst Ratings are 95% incorrect.
For the 3 months to December 12, 2020, 61 companies in the S&P500 index lost more than 10% of their stock price value. However, 95% of the analysts had a Strong Buy, Buy or Hold rating on those stocks, and only 5%had a Sell or Strong Sell Rating. See the table at the bottom of this article.
It is easy for investors to fall into the trap of relying on analysts’ ratings rather than their own opinions. Stock analysts are human beings who are often wrong.
Some analysts are experts at disguising their opinions as technical or scientific analysis. Analysts’ ratings are a useful tool for investors, but they are often inaccurate.
Major Credit Rating Agencies
The most popular stock ratings in the United States are those issued by the three major rating agencies; Fitch Ratings, Standard & Poor’s (S&P), and Moody’s.
Fitch Ratings is the third-largest credit rating agency. Fitch rates companies for creditworthiness and risk of default. To simplify the rating process, Fitch gives companies and instruments letter grades.
Fitch’s AAA rating means the company has the lowest risk of default; the lower the rating, the higher the risk of default. The AA is a slightly lower risk of default. A “C” rating means Fitch’s analysts think a company could default. An RD (Risk of default) or a “D” rating means Fitch’s analysts think a default is probable.
Fitch offers Bank Viability Ratings, Recovery Ratings, Issuer Default Ratings, National-Long-Term Credit Ratings, and National Short-Term Credit Ratings. Lenders use the ratings to set interest rates and make decisions.
Investors use Fitch Ratings to determine the margin of safety and the potential return on some stocks. A value investor could use Fitch Bank Viability Ratings to determine the margin of safety and earnings potential of a regional bank, for example.
Moody’s Investors Service (NYSE: MCO) is a publicly-traded company best known for its bond ratings. Moody’s offers credit ratings, sector analysis, and analysis of deals and IPOs.
Moodys uses the triple letter ratings Aaa, Aa, A, Baa, Ba, B, Caa, Ca, and C. C is the lowest Moody’s rating, and Aaa is the highest.
S&P or Standard & Poor’s is the best-known American ratings agency. Standard & Poor’s most notable creation is the S&P 500, one of America’s most popular stock indexes.
S&P uses the same credit rating systems as Fitch. AAA is the highest S&P credit rating, and D is the lowest S&P credit rating. S&P uses different systems for short-term credit issue ratings and issuer credit ratings. Standard & Poor’s offers several specialized ratings for other products.
S&P rates funds, insurers, currencies, and other products. S&P operates globally as S&P Global.
Credit Rating Agency Controversy
The big three rating agencies have long been criticized for inaccuracy, bias, false ratings, flawed methodologies, and conflicts of interest.
Some critics blame the Global Financial Crisis of 2008 on the Big Three credit agencies, Moody’s, S&P, and Fitch. The theory is that inaccurate credit ratings convinced bankers that derivatives, mortgages, and other securities were safer than they actually were.
A popular belief is that the rating agencies inflated the ratings of large financial institutions that were their customers. The allegation is that the agencies feared losing the institutions’ business, so they gave the institutions’ products higher ratings. One popular criticism is that the rating agencies are for-profit companies, not impartial judges.
Recent regulatory actions against rating agencies lend credence to these criticisms. For example, in 2019, the European Securities and Markets Authority fined Fitch’s European subsidiaries for conflicts of interest. In 2018, the China Regulatory Securities Commission banned the Dagong Global Rating Company from assessing bonds because of allegations about fake ratings.
All investors need to keep these criticisms of rating agencies in mind when relying on their data.
Stock Analyst Ratings Summary
Stock analyst ratings can be a useful tool for investors because they offer a glimpse into professional insights about equities.
Analyst ratings have serious limitations investors need to be aware of, however. Some ratings are vague and confusing.
I think many ratings are too-focused on market comparisons. Comparisons to markets and indexes are useful for traders and speculators.
Such comparisons will not help ordinary investors because the market and index performance may not affect a stock’s returns or value. A low-priced stock can pay a good dividend, for instance.
There are some low-priced stocks with high margins of safety, such as Ford (F). I think Ford has a high-margin of safety because it generates enormous amounts of cash and pays dividends. Mr. Market paid $9.34 for Ford on December 4, 2020, but it had $44.831 billion in cash and short-term investments on September 30, 2020.
Some stocks with high share prices have small amounts of cash and pay no dividends. Some analysts will give those stocks higher ratings because their share price outperforms the market.
Investors need to examine both the stock analyst ratings and the stocks themselves. If you see a highly-rated stock, you need to examine the stock’s financial numbers.
The financial numbers can show if the company makes money and how much money it makes. Many highly-rated stocks make no money. The financial numbers can show if the ratings are justified.
Stock analysts’ ratings are powerful but limited tools that every investor needs to understand. Many successful investors use analysts’ ratings to guide their decision making.
However, there are some famous investors, including Warren Buffett, who ignore analysts’ ratings. Buffett, famously, relies on his judgment and a close reading of the financial numbers when he picks stocks.
Many investors rely upon their judgment. Other investors will compare their picks to analysts’ ratings to see who is right.
Stock analysts’ ratings can help you become a better investor if you understand their limitations. Smart investors read analyst ratings but always view them with skepticism.
Stock Analyst Ratings Innacuracy Table
|Ticker||3-Month Return vs. S&P 500||Strong Buy Ratings 3-Months Ago||Buy Ratings 3-Months Ago||Hold Ratings 3-M. Ago||Sell Ratings 3-Months Ago||Strong Sell Ratings 3-Months Ago|
|% Analyst Ratings||52%||5%||37%||1%||4%|
|# Analyst Ratings||482||47||344||9||38|