What Does Overweight Stock Mean
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An overweight rating on a stock is set by a rating firm’s equity analysts and reflects his estimate regarding the performance of the company relative to the benchmark stock index.
In the U.S., the benchmark indices used for comparison is the Standard & Poor’s S&P 500, where the 500 leading companies are listed. When the analyst rates a stock overweight, he expects the stock to perform better than the benchmark index. He indirectly recommends that the stock can be overweighted in the investor’s portfolio.
When you screen market news headlines, you frequently read about investment analyst estimates about specific stocks with terms such as “overweight,” while other times you see “Downgrade from Buy to Neutral” or “Reiterated Buy.”
This can be imprecise, and you wonder what the analyst is trying to tell you. In general, if a stock analyst rates a stock as overweight, he believes that this specific stock of a company will perform better than its benchmark index and maybe even better than other peers in the same sector.
In contrast, if an analyst uses the term “underweight,” he expects that the future performance of the stock will not be as good as the comparison benchmark.
For the time span, the analyst typically provides guidance like “overweight rating due to recent earnings reports with a target price of $100 within the next 6 months”.
So, the “overweight” and “underweight” ratings are kind of similar to what you likely assumed – a buy and sell rating. However, it is a bit more complex, so let’s look closer at it.
Analyst houses typically use two rating systems – the three-tier and the five-tier.
Three-Tier Rating System
The three-tier rating system is easy to understand. Buy means buying the stock, hold means holding the stock in the portfolio, and sell means selling the stock.
You notice there is no overweight and underweight in this three-tier rating system, but it comes into play within the five-tier rating system:
Five-Tier Rating System
The classic stock analyst rating system consists of buy, overweight, hold, underweight and sell:
As you can see, buy, hold, and sell are similar to the three-tier rating system, and the terms overweight and underweight are classifiers in between. That means the rating analyst tends to recommend buying the stock, but it’s not there yet. While the analyst expects the stock to perform better than the benchmark index, he does not expect the stock to perform that well, so the buy recommendation should be given.
Once his analysis indicates that the stock is the best stock to buy now, he initiates a buy rating. E.g., if he identifies undervalued stocks and the analyzed company earnings suggest solid future growth, he might initiate buy ratings after previously setting overweight ratings.
In other words, if the rating house uses a 5-tier system and gives an overweight recommendation, this is better than a hold rating but not as good as a buy rating.
On the flip side, if he weighs a stock with underweight, the analyst does not recommend selling the stock yet, but chances are that with the next earnings release, the rating could finally drop from underweight to sell.
What would be the finance world without variations? There is also a variation of the five-tier rating system. In the first version above, you see that the overweight and underweight came in between the buy and hold and also between the hold and sell rating of the 3-tier rating system.
The alternative stays with the three-star rating system terms in the same order but adds two variations. Instead of overweight and underweight in between, it adds the words strong to the buy and sell recommendation:
- Strong Buy
- Strong Sell
- The components of the three-tier rating system are included in all rating systems. Those are buy, hold and sell.
- Rating firms who want to be more diversified about their ratings might expand the rating system from 3 tiers to 5 tiers.
- There is no specific wording classification that’s similar across all analysts, banks and financial institutions. That’s why you find different wordings across multiple rating sources.
- The analyst rating can still hold true even if a stock price falls. If the benchmark index fell by 50%, the rated stock fell by 40%, and the analyst said “overweight,” he still was right since the stock performed better than the overall market.
What The Term Weight Means for the Stock Rating
The term weight in stock means that the analysts who initiated the rating expect the stock performance between neutral + buy and neutral + sell. Being overweight is better than neutral, but not a buy recommendation yet. Underweight is worse than neutral, but not a sell recommendation yet.
Why Does the Weight Reference Exist
Investment firms hire stock analysts to analyze intensively and research stocks to come up with a rating. They use software to analyze the company fundamentals and charts. The weight rating is added to expand the traditional buy, neutral, and sell ratings by overweight and underweight.
The weight rating shell helps investors when rebalancing their investment portfolio. Diversification of a stock portfolio is important. That’s why many investors hold multiple stocks. All investors are interested in holding stocks that perform better than the average. The weight rating intends to help investors to understand what the analyst expects about the performance of the stock relative to the benchmark indices.
The investor needs to decide whether to use the analyst rating or not, and it might help him to confirm his personal opinion. One thing to remember, though. If an analyst rates a stock, the rating is in comparison to his expectations relative to the overall market or indices and not a comparison to specific companies.
Market Leading Analysts
- D.A. Davidson
- TD Securities
- Wells Fargo
- Piper Sandler
- Morgan Stanley
Rating Guidelines vs. Buy Recommendations
Ratings are guidelines and not buy recommendations. While the analyst typically provides a profit target for the rated stock, he does not directly say buy it because it will make you money. Instead, he analyzes the stock and provides a rating based on his analysis.
The efficiency of ratings is difficult to track because analysts frequently change their opinion and neither provide an entry signal price nor a stop loss level, but only a potential profit target.
In contrast, a stock picking service directly names a stock and provides an exact entry price, stop-loss price and profit target. With such a trading service, or by using stock investment newsletters, you can directly measure the efficiency of the stocks and often see the entire history of previous stock picks and buy recommendations.
What Does Overweight Stock Mean Conclusion
An overweight stock rating means that the analyst who issued the rating expects the rated stock to perform better than the overall market but not that good that he would provide a buy rating.
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