An analyst rating is a valuation assigned to a share by a stock analyst. There are many investment banks and independent analysts that rate stocks according to their house style.
These ratings are updated periodically to either upgrade to a higher value, remain the same, or downgrade when a company does not meet expectations.
The most common analyst ratings are Buy, Hold, and Sell.
Buy: A Buy rating indicates the analyst is bullish on the stock.
Hold: A Hold rating indicates the analyst does not expect the share price to bring positive or negative returns in the near term. There’s no compelling reason to sell or to buy.
Sell: A Sell rating indicates the analyst is bearish on the stock and believes a negative total return is likely.
Overweight: An Overweight rating shows the analyst expects the stock to outperform the broader market averages.
Market weight: A Market Weight rating indicates the analyst believes the stock will continue to perform in line with broader market averages.
Underweight: An Underweight rating shows the analyst expects the stock to underperform its broader market averages.
How do analysts decide their ratings?
It is the job of the analyst to thoroughly research and consider a company’s current and future position before labeling it with an analyst rating.
This process involves reading financial statements in the public domain, listening to earnings calls, or reading transcripts of these calls. It also involves discussions with company managers and customers to gauge sentiment on the company’s performance.
From here, the analyst can make an educated decision on how they believe it will perform in the coming period.
Considerable time and effort go into the rating decision-making process. Therefore, analyst ratings can give investors and stock traders a good starting point when considering buying shares in a stock.
Along with the rating and price target, the analyst often releases an extensive research report, earnings per share (EPS) predictions, and revenue for the coming quarters and next year or two.
These reports are occasionally available to the public and sometimes only released via certain brokers or investment banks.
Types of analyst ratings
In addition to the standard analyst ratings of Buy, Hold, and Sell, individual analyst firms vary in the way they present their ratings to the public.
Other common terms include:
A full definition of analyst rating scores is usually displayed on the analyst’s website.
For instance, RBC Capital Markets provides an explanation of its Capital Markets Equity Rating System on its website:
Outperform (O)): Expected to materially outperform sector average over 12 months.
Sector Perform (SP): Returns expected to be in line with sector average over 12 months.
Underperform (U): Returns expected to be materially below sector average over 12 months.
Restricted (R): RBC policy precludes certain types of communications, including an investment recommendation, when RBC is acting as an advisor in certain mergers or other strategic transactions and in certain other circumstances.
Not Rated (NR): The rating, price targets, and estimates have been removed due to applicable legal, regulatory, or policy constraints, which may include when RBC Capital Markets is acting in an advisory capacity involving the company.
Averaging analyst ratings
Many analyst ratings are aggregated across stock websites. These give weight to each rating on a scale of 1 to 5.
Advantages of analyst ratings
Analyst ratings give potential stock investors a quick way to gauge institutional sentiment around a stock. When several analysts have rated a stock, the consensus rating can give the investor or stock trader a good idea of professional feeling towards the company.
The analyst rating usually comes with a share price target of where they see the share price approaching within a certain time period, such as 12-months.
When it comes to revenue and EPS predictions, analysts can be fairly accurate.
Disadvantages of analyst ratings
The downside to analyst ratings is that they are purely one individual’s perspective and cannot be solely relied upon to make an investment decision.
Analyst ratings are often wrong, which illustrates how difficult it is to predict short-term moves in the stock market.
Sometimes the financial press will make a fuss in highlighting a single analyst rating. This can be misleading and should be taken with a pinch of salt.
Stock analysts may be conflicted in their loyalty and decision-making process. For instance, their employer may hold a position in the stock, which could sway their ratings.
Sell ratings sometimes encourage investors to short the stock, which can add fuel to the fire and a rapid decline in the share price.
Analyst ratings are often wrong. Therefore, investors should be cautious when interpreting the ratings and never take them at face value. Investors must do their own research and reach their own conclusions before buying or selling stocks.
Where’s the value in analyst ratings?
An analyst rating provides a potential investor with a quick assessment of a company.
Upgrades and downgrades often lead to significant share price movements.
Analysts are not always right and make no guarantees. Nevertheless, many institutional and retail investors use analyst ratings and reports to assist in their investment decisions. This can create a self-fulfilling prophecy and drive the share price in the direction the rating indicates.