A significant proportion of stocks on the market have analysts that follow their every move. They participate in quarterly calls and analyze financial statements, the sector, competitors, and future opportunities. Analysts will assign a rating to the stock when they understand the business globally. This rating is very subjective as there aren’t universal guidelines. Two analysts can come to opposing conclusions, and both might be wrong. Earlier in the year, we posted an article about some of Wall Street’s top analysts; read about it here. Reading the analyst’s notes and looking at their previous ratings is important. For investors, these ratings are another tool in their due diligence box. This article will explain what every rating means and give investors other tools to understand this grading system better.
What are Stock Ratings and Analysis Types?
Stock analysts have been around for as long as the stock market. Their input can be very valuable when it isn’t biased. In fact, there are two types of analysts:
Buy-Side: Buy-side analysts work for investment firms, mutual funds or asset managers. They might ‘’initiate coverage’’ to eventually buy the particular stock or they already own it. Their rating might be biased since they own the stock and want more investors to follow their recommendation to make a profit.
Sell-Side: Conversely, sell-side analysts sell their research to buy-side analysts. Their actions are closely monitored since they work with the companies mentioned in their research. They have to provide accurate information.
Now that we understand the two types of analysts, let’s take a look at the realm of possibilities for their ratings.
Types of Stock Ratings
Below is the scale ranging from the most bullish to the most bearish. Analysts usually change their ratings every quarter. So it can be in line with quarterly earnings reports. Analysts will also share their target prices for each stock.
Buy: Sometimes, it can also be a ‘’strong buy”. Analysts believe the stock’s price will increase shortly. In addition, an upcoming catalyst will propel the stock up. Overall, analysts are more than optimistic.
Outperform: An outperform rating means the analyst expects the stock to beat a certain benchmark or the stock market as a whole, but not by much. Nevertheless, it remains a bullish rating, and it is synonymous with overweight.
Hold: This is a neutral rating. Companies with this rating are expected to perform at the same level as major benchmarks and other companies in the same sector. It isn’t a buy or a sell. Existing positions should be maintained, and no new positions should begin. There is some uncertainty surrounding the company with its upcoming earnings and guidance.
Equal-Weight: Stocks with this rating will likely perform very closely to their competitors in the same sector.
Underperform: Synonym to moderate sell, weak hold, and underweight. This rating means the stock will likely do slightly worse than the overall market. A positive return is still expected, but don’t expect much. Bearish ratings begin with underperforming.
Sell: It can also be a ‘’strong sell”. Very self-explanatory, if you own this security, it’s recommended to sell it. A company with this rating will likely face difficulties shortly, and its stock price will decline. Some analysts attribute the neutral rating as well.
What Are the Pros and Cons?
As we mentioned earlier, analyst predictions aren’t always on point. In addition, investors have other tools, such as technical and fundamental analysis, to have a complete picture of the stock and industry.
Pros:
Reliable Data: Analysts studied to get there. They also spend more than 15 minutes (hopefully) analyzing the stock. Their ratings are based on reliable data and forecasts. As a result, they have a good overall picture of the stock and the industry.
Convenience: The majority of stocks traded on various exchanges have a rating. This makes it easier for investors to know where the stock and industry are going. In addition, analysts often leave notes for investors. Some of the research is already done for us; additional resources can be found in the notes.
Cons:
Inconsistency: Every quarter, analysts review their ratings. A stock can easily go from a buy to a sell in months due to new legislation on industry requirements. Sometimes, an analyst’s opinion can change a stock’s trend.
Biased: We mentioned earlier that some analysts have ties to the companies they are reviewing, and they can hold their stocks. They might assign a favorable rating in exchange for favors or their benefit. According to a study, sell ratings are only 5% of all ratings. More than half the ratings assigned are bullish.
Information: The rating alone isn’t enough due diligence. Before purchasing the stock, more research has to be done. Technical and fundamental analysis are your friends. Online forums can also be a good place to start for other investors’ opinions.
Who Are Stock Analysts?
There are three major US rating agencies for stocks and bonds: Standard & Poor’s, Moody’s Investors Services, and Fitch Ratings. Major financial institutions also have analysts that provide ratings.
They often specialize in individual sectors. Some analysts also have independent online platforms that post relevant information about the stock market and industry analysis. They did their studies to become an analyst but decided to have an independent business. For example, I trade with TD’s platform. They have various analysts’ ratings on the stock page to make it easier for their clients.
Real Life Examples
Below, we will give a few examples of analyst ratings and predictions for popular stocks. All prices are before the market opens on May 26, 2023.
Alphabet (NASDAQ: GOOG): Price – $124.35. Google has a current overall rating of Strong Buy. For the next 12 months, analysts predict a floor value of $132.50 and a ceiling of $165. The average analyst predicts a 38% upside based on current public information.
GM (NYSE: GM): Price – $32.41. GM has a current overall rating of Buy. However, for the next 12 months, analysts aren’t all on the same page. Some were assigned a sell rating, while others were assigned a strong buy. Price targets range between $29 and $87. The latter would be an all-time high stock price for GM. The average price target gives GM a 52% upside.
Tesla (NASDAQ: TSLA): Price – $184.47. We conclude this section with Tesla. You can read our analysis here. Analysts are all over the place with their price targets. Tesla is the perfect example of a stock that needs a lot of due diligence. Analysts aren’t a good source of information here. Their price targets range from $73 to $1580. However, most assign a buy rating compared to a 23% sell rating.
Note: These prices are before the 3-for-1 proposed stock split for Tesla, which happened on 8/25/22
What Are Stock Ratings Conclusion
To conclude, stock ratings are given by analysts working for various financial institutions and private companies. They are a tool for investors to make an informed decision before purchasing a stock and investing in an industry. As we saw with the three examples in the last section, analysts aren’t always on the same page. Their research can yield different results. This is why it’s important to conduct additional due diligence with the help of technical and fundamental analysis. Analysts aren’t perfect, and they might be biased in their conclusions. Before purchasing a stock, making an informed and complete decision is essential.
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