A stock that is expected to outperform other stocks in its market sector gets an Overweight rating. Financial analysts who are employed by investment firms research stocks and provide their opinions to investors about their possible future performance. Their opinion takes the form of a rating. An Overweight stock rating indicates to investors that it may be a good investment. A financial advisor can help you figure out whether an Overweight stock is a good fir for your portfolio.
Why Is a Stock Rated Overweight?
A stock is rated an Overweight stock by analysts when they discover factors that augur good price performance over the next six to 12 months. The Overweight rating is given when the analyst thinks the stock will outperform other stocks in its market sector or those in a market index like the Standard and Poor’s 500.
Analysts must be able to justify an Overweight rating since it will affect investor behavior. Investors will think an Overweight stock is a good addition to their portfolios and buy the stock, which will drive up the stock price. Existing investors in the stock may take the opportunity to load up on the stock. Portfolio managers may increase the weight of the Overweight stock in their portfolios in order to possibly earn excess returns.
A stock given an Overweight rating is probably experiencing growing earnings. It also could be beating quarterly earnings expectations. There are a number of possible scenarios that could contribute to growing earnings. An Overweight stock may have purchased another company that substantially broadens its product line or strengthens one or more existing product lines or distribution channels. Research and development by a company may have led to the identification of a new process or some type of innovation. The company could have discovered a new segment of the market interested in one of its products or a new use for a product.
In the lingo of the finance world, there are other terms an Overweight stock may be called. It may be called a Buy. Similar terms are Accumulate, Add and Outperform.
Understanding the Ratings Systems
There are two primary ratings systems for securities. There is a three-tier system and a five-tier system. The three-tiered system is the one that uses the Overweight rating. The other two tiers are Underweight and Equal Weight. The second system is a five-tiered system. The five-tiered system ranks stocks as Strong Buy, Buy, Hold, Underperform and Sell. Be aware that different investment firms and analysts may define these categories differently. For example, a Strong Buy might be defined by one analyst as a stock that is expected to perform 25% better than the market. Another analyst might define a Strong Buy recommendation as a stock that will perform 15% better than the market for the next six to 12 months
More common than Strong Buy is a Buy recommendation. To compare the two systems, an Overweight stock rating usually falls somewhere along the scale between Buy and Hold or, sometimes, between Strong Buy and Buy. The interpretation of the Buy recommendation runs the gamut. Some analysts issue a Buy rating if the stock is supposed to outperform the market by 15% over six to 12 months. Other analysts don’t specify a time period.
Benchmarking Against the Market Index
The stock market is represented by a number of market indices that track the performance of both the broad market and specific segments of the market. The choice of the right market index with which to compare a stock is crucial. Some indexes use weighting systems based on factors other than market capitalization. There are many market indices from which to choose representing nearly every possible classification of stock and market sector.
The Standard and Poor’s 500 index is a widely used market index that includes the shares of 500 large companies. This index is popular because it is a widely held opinion that it may represent the overall market most accurately. Each stock in the index has a weight based on its market capitalization. When a stock is rated as Overweight, the analyst is effectively saying that the stock deserves a higher ranking in its index.
Morningstar also has a ratings service. This service focuses more on ranking mutual funds according to its criteria than stock although it does also rank stock.
Investing in Overweight Stocks
Investors should use a number of criteria before they rate a stock as an Overweight stock. There are approximately 7,500 analysts on Wall Street. They have different opinions regarding whether to rate a stock as Overweight. They may have a different risk preference than yours or they may have different investment time horizons. There are many variables and techniques in stock valuation. Consider more than one or two financial analysts’ opinion before you invest.
An Alternative Definition of Overweight Stock
In a portfolio context, the word Overweight may be used if you have more of a specific stock in your portfolio than exists in the market index. If you own 20% of a stock that has a 6% weight in the market index, you are said to be overweight on the stock.
The Bottom Line
The ranking systems for stocks looks simple. The analysis that goes into finally determining the rank of a stock as Overweight is anything but simple. A wide variety of factors are taken into account by financial analysts and they may have differing opinions. Analysts’ recommendations should only be used as suggestions regarding your investment decisions. There are other factors to consider such as the valuation of the stock, your own risk preference and your investment time horizon. Keep in mind, too, that similar ratings can be found for stock funds.
Tips on Investing
- It’s often a good idea to work with a financial advisor on choosing investments. Ask the financial advisor if they have a background as a financial analyst. If not, perhaps they can refer you. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s financial advisor matching tool can help you connect with a professional advisor in your local area in minutes. If you’re ready, get started now.
- In order to help you construct your investment portfolio, try out SmartAsset’s asset allocation calculator. You can enter your risk tolerance and get some help in choosing securities for your portfolio.
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