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What are Analyst Ratings?
Analyst ratings measure the expected performance of a stock during a given time period. Analysts and brokerage firms often use ratings when they issue stock recommendations to stock traders.
Analysts arrive at stock ratings after they research companies’ public financial statements, communicate with executives and customers and interact with companies in other ways.
Most analysts issue ratings 4 times a year, usually at 3-month intervals.
How to Use Analyst Ratings
As an investor or trader, you want to be able to use analyst ratings effectively. Here are steps you can take to understand how to synthesize all the information analysts report about a particular company and how to apply it to your own trades.
Step 1: Check ratings history.
In the short term, look to see whether analysts suggest an initiation, upgrade or downgrade for a particular stock. Understand how the rating changed compared to the previous rating and whether a price target gets announced or changed.
Sometimes the rating stays the same and only the price target changes, which could cause the stock to move in either direction, depending on the significance of the change between the 2 price targets.
Step 2: Check for other news.
In the short term, check to see how the stock reacts to positive or negative news. This will be an indication of the company’s outlook because analyst ratings usually come out after the company announces news (it’ll typically be earnings news).
Step 3: Look at the sector for news.
Check to see if other stocks in the sector also received similar ratings. This could indicate micro news, which refers to when the whole sector or specific company trades in a specific way due to news outside of one company.
Step 4: Look at the note.
If available, look over the analyst note itself. The beginning of the note has the main information of the rating and price target. Investors should also take a look at the summary of the note, which you can find in the first couple pages and give you a concrete overview of the company. This can help you get an understanding of how analysts arrived at their thesis on the stock.
An example of an analyst note. Source: Needham
Step 5: Make a decision.
After reviewing the analyst ratings (and whether the analyst proposes a change or initiation) and find the reason for that note. Make a decision based on the analyst thesis on the company. This should give you guidance on how to make your thesis. Analyst ratings are a good indication of what the professionals believe in the company or sector to help you get a better understanding of companies you’re interested in.
Analyst Rating Accuracy
Analyst ratings are not set in stone and nobody knows indefinitely what a stock will do. Therefore, analyst ratings should be taken as an educated guess made by professionals who carefully study the specific company and sector in question. It’s not a surprise that the accuracy of each rating can vary by each individual analyst and specific ratings on companies.
In other words, there’s no hard number or percentage on how accurate analyst ratings are because they are like educated guesses on what they think the stock will do based on their research and within that particular sector. In addition, each firm has so many analysts and so many different companies and you should use analyst ratings to inform your own trade ideas.
Where Analyst Ratings Come From
Analyst ratings come from stock analysts. Analysts “go deep” on companies within a particular industry or sector. Some analysts employ a top-down approach (they start with an industry or sector and look for excellent companies within that industry or sector) and other stock analysts choose a bottom-up approach, which means they start with the company first and connect the dots within that company’s sector or industry. Analysts evaluate:
- Financial statements
- Economic fundamentals
- Suppliers, customers and competitors
- Management quality
- Business model
Types of Stock Ratings
Stock ratings can range from simple “buy” and “sell” ratings to “equal weight” and “outperform” ratings. Here’s a quick overview of how analysts rate stocks.
A “buy” rating indicates that an analyst is optimistic about a stock’s short-term or mid-term growth and recommends that traders purchase the stock. An analyst may even go so far as to indicate that a stock is a “strong buy.”
A “sell” rating means that an analyst believes the stock will trend downward in a particular time frame. Analysts might even refer to a security as a “strong sell.”
A “hold” rating suggests that investors should not buy more of or sell the specified stock because they believe the stock should perform in a way that’s consistent with the market or will perform similarly to comparable companies within that particular sector.
An “underperform” rating means an analyst indicates that a stock is expected to perform below the market or sector average.
An “outperform” rating means that an analyst expects a stock to outperform the market or sector average.
An equal weight rating means that an analyst believes that an individual stock’s performance will tie to the average of all the stocks that an analyst covers in that particular sector. This type of rating helps investors get a true comparison of stocks to each other within a particular sector or industry.
A price target is an analyst’s projection of a stock’s future price.
Should You Use Analyst Ratings to Inform Your Own Trades?
You can definitely use analyst ratings to inform your own trades and inform your own thesis but it’s a good idea to do your own research.
Visit Benzinga News for more guidance on how to research companies and make decisions about research, trading and investing.