I have been watching stocks for nearly 25 years now, and many investment terms like “overweight stock” still can be confusing to many experienced investors like me. So it is very natural for many investors to not fully understand terms like overweight rating.
Some Investors may even think that investment analysts in the stock market conjure up fancy terms like “overweight rating” in their lingo just to confuse the ordinary investors instead of a simple and actionable “buy,” “sell,” and “hold/ stay” trinary.
Take “overweight” or “overweight stock rating,” for example, a term pretty regularly used by many analysts. Or it inverse “underweight.” Of course, the ordinary investor is smart enough to not get defensive about her own waist size each time she reads investment advice columns and encounters “overweight.”
What does the overweight rating mean? The short answer is that an overweight stock meaning is a positive rating that indicates an excess to the benchmark or portfolio for the next 12 months. It can also apply to the industry sector. Unfortunately, the term so commonly used by investment analysts does not have a crystal clear definition and may have slightly different meanings in different contexts. That being said, some common systems have evolved over the years to which most recommendations are confined, the three-tier and five-tier ones being the most commonly used.
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The Overweight Stock Meaning Explained
An analyst using the three-tier scale might summarize his stock recommendation in one of these three actions: “Buy,” “Hold,” and “Sell’” “overweight rating” is one of the more common terms in the stock market.
On a five-tier scale, two additional levels will be snuggled in, usually on either side of “Hold” before the “Buy” or “Sell” recommendation is reached, indicating a slightly lower than a ringing endorsement for that action. Thus, “overweight” in most five-tier recommendation scales can be considered to be a “buy” recommendation but a little less enthusiastic than a ‘buy’ rating.
Similarly, “underweight” in most recommendation scales can be considered to be a “sell” recommendation but a little less enthusiastic than a ‘sell’ rating on a five-tier scale.
Many analysts do not use “overweight,” relying on “outperform,” add” and “accumulate” instead, and “underperform,” reduce’ and ‘weak-hold on the sell-side.
But, how does it work if the analyst uses a three-tier scale?
Good question. In such a scenario, “underweight,” “equal weight,” and ‘overweight” is perhaps the most common classification, where “overweight” is as close to a “buy” recommendation as the firm is comfortable in issuing.
Why the Reference to Weight Is Used
Your portfolio should be made up of a diverse mix of stocks and other investments. When you have a good mix like this, it means that your portfolio is properly “balanced” You should try to avoid being too heavily invested in any one thing. If you don’t have enough of a certain investment in your portfolio, you are considered “underweight” If you’re underweight, you’re considered “overweight” in the S&P 500 index.
The Relevance of Weight
To make matters more confusing, the weight analogy is used in other situations as well, not just a stock.
Many an analyst and broker rely on a balanced portfolio being the bedrock of an investment strategy. When an investor does not have a balanced portfolio, it means she has too much of one stock or type of stock in her portfolio since too little in a portfolio is the stable state, there being thousands of options to choose from; she will always be underweight on thousands of stock she does not have in her portfolio.
The modern portfolio theory promotes diversification of the market by buying stocks in different sectors. That way when a stock price goes down, it is not pulling the whole portfolio down. Some advisor and managers prefer to weight difference sectors differently, while others try to keep them all the same. Theoretically, it is very hard beat the performance of benchmarks of indexes if you are not weighting sectors differently.
Below is a great video by Jim Creamer using “overweight” in a stock sector movement.
Being heavily exposed to one stock or type is also called being ‘overweight’ in it.
This use of “weight” is also perhaps similar to its meaning in the classical sense of the language.
Indexes, such as the S&P 500, are also based on the market capitalization of stocks and typically define its “weight” in the index. Apple had a 5.74% weight in the S&P 500 in July 2020 because of its market capitalization at that time.
By rating a stock as “overweight rating” the analyst is also saying that the stock deserves a higher weight in the index that it is a part of, on the basis of future performance which is likely to increase its market capitalization in relative terms to other stocks.
“Underweight” and “overweight” can be used in reference to not only individual stocks, but sectors as well. An analyst could recommend that Retail is overweight which means that he expects a better performance from Retail stocks relative to stocks of other sectors.
Is an overweight stock good?
When a stock is labeled as “overweight” it is a good label for the stock. This is because the analyst thinks the stock will outperform the broader stock market in the near future and is “buy.” There is no guarantee that the particular stock will do better than the market. Lastly, it does not factor in risk or price, but only that the stock will perform better than the benchmark.
Does overweight mean buy or sell?
An overweight label is a definite buy recommendation and could lead to a gain in the stock in the future. Just because the analyst use the term overweight, doesn’t give any guarantee that it will outperform or the price will reach a certain level. Investors should always research their own stocks and buy investments that are suitable to their overall portfolio and risks.
An Investment Analyst – Where does He Fit in?
There being thousands of stocks to choose from, it is easy to understand that it is not possible for each investor to follow the advice of gurus and research the fundamentals of a stock before making decisions. Most researchers rely on one or more investment analysts, also called stock analysts or research analysts, for their investment-related decisions. In general, analyst recommendations are understood to be relevant for a 6 to 12-month time horizon.
An overweight recommendation is a positive thing for a company stock’s value because it means that analyst believes that the security will outperform in the future against a benchmark or index in the future.
While analysts do issue detailed reports on the stocks they study, even these may be too voluminous for many investors to either study and/ or understand. Most look for the “bottomline” recommendation of the analysts.
Take Overweight Rating with a Pinch of Salt
In simple terms, by rating a stock as “overweight rating” an analyst is suggesting that it is expected to perform better than other competing options available to investors and should be taken as a suggestion to buy the stock.
However, we all know that nobody can see the future. An analyst is only another human being who provides stock recommendations based on information in his possession and his analysis of it. Many analysts differ in their outlooks on the same stock. Besides, all stock recommendations are issued with a lot of caveats and disclaimers.
As an investor, an analyst’s stock recommendation should be taken for what it is, an additional piece of information in the puzzle that constitutes investing. It is not gospel. There are no guarantees.