Analyst Ratings and Price Targets (12/8/2019)

 

Terms like “Buy”, “Sell”, and “Hold” are synonymous with financial analysts’ reports, yet very few people have a clear understanding of what they are and the best way to use them for value generation in the stock market.  The terms are usually the result of thorough investigations carried out by brokerage firms and analysts as they look to make it easy for investors to make informed decisions about investments.

Market ratings are a multi-level recommendation system based on facts and the opinion of a financial analyst. The fact that there is a multitude of firms issuing differing ratings and a lack of a standard terminology explains why it is essential to understand what the ratings are all about and their meaning before using them for investment decisions.

What Are Stock Ratings

A stock rating refers to an evaluation of a stock’s expected performance in a given time period.  The rating is usually accompanied by a target price that analysts or brokerage firm issue with the aim of helping clients understand what is the fair price of a stock compared to its market value.

A stock rating will often come with a price target that shows what analysts believe is the fair value for the stock. Whenever the price target exceeds the market value, then it implies analysts believe the stock is a buy.  If the market price for the stock exceeds the target price, analysts or brokerage firms would say that the stock is a sell.

Understanding Analysts Stock Ratings

Analysts' ratings range from a simple buy, sell or hold to an equal-weight, overweight or outperform. Many brokerage firms rate a stock on a scale of one to five stars, with five being the highest rating. The ratings are assigned depending on the kind of earnings the company has reported or what it is expected to report as well as on valuations and stock price.

Corporate governance, as well as the scalability of a company’s business, are also taken into consideration when rating stocks. Analysts also pay close attention to a company’s competitive edge in the industry, as it is known to affect performance most of the time.

Market conditions also play into how stocks are rated. For example, in a bull market, analysts are usually swayed to keep favorable ratings for a long time while upgrading share price target. Conversely, during a bear market, analysts may resort to downgrading stock ratings.

While ratings may seem straightforward to an investing newcomer, in reality, a rating from one brokerage firm may mean an entirely different thing in another firm. For example, an outperform rating issued by one firm may mean a buy for another firm, while a sell may mean under­perform.

When it comes to integrating analysts' ratings, it is important first to review a firm’s rating scale to get a full understanding of what it is all about and what it means.  For example, a stock with the potential of delivering a 15% upside in price may be rated as a buy while one with a 5% upside rated as a hold.

Types of Stock Ratings

Buy Stock Rating: A buy rating indicates that a stock is worth buying at a given market price as it is destined to rise. Some firms use ‘strong buy’ to indicate how confident they are that a stock will climb higher given the strong fundamentals backing a move on the upside.

Sell Stock Rating: Sell recommendations are normally issued whenever analysts believe a stock is overvalued or fundamentals do not add up to support any movements on the upside. Some firms use ‘strong sell' to indicate that it is time to liquidate the security.

Hold Stock Rating: A security hit with a hold rating is most of the time expected to perform at the same pace as other stocks in the sector.

Underperform:  Analysts issue an underperform rating whenever they feel a stock is likely to fair worse than the overall market.  The rating is most of the time expressed as a moderate sell, warning investors who are long that a stock is losing upside momentum.

Outperform Stock Rating:  An outperform rating indicates that a stock is likely to perform much better than the market when it comes to returns. Also known as moderate buy or overweight, the rating hints at an uptrend gaining momentum.

It is important to read each rating definition to have a clear understanding of what it means given that ratings from different firms do differ a great deal.  Some ratings do offer specific recommendations while others are usually general in nature. One firm may say it expects a stock to appreciate by between 10 and 20% while another firm may say it expects a stock to appreciate over the next 12 months.

Why Stock Ratings Matter

While investors have a love-hate relationship with stock analysts’ ratings, they still matter a lot, as they convey how professionals feel about a given security. They will always stand out in part because they are the result of reasoned and objective analysis of experienced professionals.

Analysts and brokerage firms spend a good amount of time and effort to analyze companies in a bid to come up with accurate stock ratings that investors can rely on for making informed investment decisions. Investors should always remember that analysts do their best with stock ratings to find good investments for their clients in order to secure their reputation in the industry as well as the commissions they earn for such pieces of information.

Legitimate ratings will always be valuable pieces of information that investors can rely on to beat the market and in the process generate substantial returns. However, while it is essential to always be on the lookout for analysts’ ratings, it does not mean that investors should always adjust their position based on such reports.

Such reports should only be used to complement individual research work prior to making an investment decision.  Stock analysts’ reports should thus be used to find a company with a durable competitive advantage.

Stock ratings are a great place to start when selecting stocks

Stock analysts' rating pages are a great place to start when looking for potential stocks to invest in. Such recommendations go a long way in providing insight on stocks that are performing and likely to perform even better going forward.

Reputable analysts and brokerage firms issue recommendations upon carrying out extensive research of a company’s operations and performance. The analysis also takes into consideration some of the market conditions that are likely to affect a company in the long run.

By going through such research pages, one can get an insight on where to start when carrying out due diligence on the stocks to invest in. In addition, such reports may provide common investment strategies that one can deploy on a given stock to be able to generate some returns.

Before making an investment decision, it is essential to consider analysts' ratings in addition to other metrics. Analyst’s ratings are never 100% accurate, which means they cannot be taken at face value.  That said, it is important to analyze everything from P/E ratio to earnings per share as well as dividends, risk, and growth of financial strength.

The key to success is analyzing below the surface when it comes to stock analysts' ratings. Never assume that just because a stock is rated a buy, it means it can be bought at any time at any price.

Bottom Line

Analysts’ recommendations in the form of stock ratings are the foundation of equity research reports that should always be used in combination with other personal research work for investment decisions. Buy, sell and hold recommendations should never be put to use without first understanding a firm’s entire scale of ratings.

It is also important for investors to note that analysts and brokerage firms also have agendas. While an analyst's obligation should be to retail shareholders, in reality, that is not always the case.

Some analysts are employed by institutions that own stakes in companies they have already initiated coverage on. Large financial firms, as well as hedge funds and securities, do benefit from certain analyst ratings. When such sums are at stake, it is common for these analysts to issue ratings that are favorable to their holdings, which may not be an accurate reflection of the market conditions.

However, that does not mean that an analyst’s ratings are useless. Analyst's stock research reports do contain vital information. Such information when complemented with other information found by carrying out due diligence could go a long way in helping one make a profitable investment decision.  Stock ratings should always be used as a source of data that complements one's research rather than completes it.