What Are the 4 Types of Stock Ratings & Is It a Good Idea to Follow Them?

By Chika

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Last Updated: February 19, 2022

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Those who follow the market closely are usually confronted with stock ratings from financial analysts covering a particular stock or sector.

When such information is made public, they usually have significant implications on the price action of the stocks in question. 

But what are stock ratings and how can investors use them to make better investment decisions? This article dissects ratings on stocks and how investors can use them to optimize portfolio gains.

 

What Are Stock Ratings?

A stock rating is a measurement of a stock's projected performance over time.

Traders can evaluate a stock's fair price by comparing it to its market value, which is why ratings are frequently accompanied by a target price.

Financial analysts arrive at stock ratings after reviewing public financial filings, speaking with executives and customers, and listening in on conference calls.

Most analysts give ratings four times a year, at three-month intervals. Stock ratings are usually accompanied by a target price to help traders comprehend a stock's fair price in comparison to its market value.

 

4 Types of Stock Ratings

1. Buy Rating

When analysts issue a buy rating on a stock, this is a recommendation to buy.

This rating indicates that analysts predict a stock's price to rise in the short to medium term. This may be due to existing near-term factors, such as:

  • the launch of a new product/service or
  • a return to profitability
  • favorable government policies
  • increased market share and profitability

Strong buy ratings are often accompanied by extremely optimistic price targets on the stock, such as a 40% to 50% gain over the coming 10 months.

2. Sell rating

A sell rating indicates that a stock should be sold.

This rating indicates that analysts expect a stock's price to fall below its current level in the near to medium term. This could be due to near-term catalysts such as loss of market share, changes in government policies that are considered unfavorable, or mounting losses.

Analysts that assign a company a strong sell rating predict its price will fall drastically below its current level in the near future. Strong sell ratings are not just gloomy recommendations but serve as a warning to investors to avoid having such stocks in their portfolios.

3. Hold

When an analyst assigns a hold rating to a stock, they anticipate it to perform in line with the market and at a similar rate to similar equities.

This grade instructs stock brokers not to sell or buy more of a particular stock.

When a company's new products/services, direction, or upcoming quarterly report cards are all questionable, a hold grade is frequently awarded. Financial analysts may offer a hold rating if a company is unsure whether or not it will fulfill its guidance, even if it is still generating good earnings.

4. Outperform

Also known as "market outperform," "overweight," or "moderate buy,",  an outperform rating indicates that an upswing is gathering traction. 

A stock is given an Outperform rating if it is expected to deliver higher returns than the market average or a benchmark index.

For example, if the total return on Apple stock is 20% and the S&P 500 returned 14% within the same period, the stock will have outperformed the broad-based index by 6%.

This rating is often regarded as a strong indicator that the rated stock is an excellent purchasing opportunity by investors. Some brokers and analysts even use it instead of strong buy.

If a company's profits/revenue growth is quicker than expected, or if it is in a sector or industry that is under pressure due to market conditions, a stock may be rated 'Outperform'.

 

Should You Follow Stock Ratings?

Stock ratings can be advantageous because they offer a quick insight into a stock's prospects from a professional point of view.

They expressly convey an analyst's view of a particular stock based on fundamentals and economic outlook. 

On the other hand, stock ratings can often be used to mislead the investing public. 

Investors have to recognize ratings are the opinion of one or a group of people. Apart from the fact that their forecast on the stock may not be accurate, the analyst may also have a vested interest in the stock. As such, stock ratings should always be considered with care and in the context of other relevant information.

 

Final Thoughts

Analysts' opinions on a stock are expressed in ratings.

Analysts put in a lot of time and effort to analyze a stock and come up with a rating. That is, ratings are the product of knowledgeable professionals' impartial and reasoned appraisal of equities. As a result, ratings are a useful tool for stock traders.

Traders must, however, conduct their own due diligence because stock ratings are only a starting point and are far from foolproof.

Photo by Nataliya Vaitkevich from Pexels

 

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