When analysts recommend stocks, they often use such terms as `overweight', `underweight', `outperformer', `neutral' etc. I thought that you could only buy, sell or hold a stock. What do these terms mean?
They are often just investment-speak for a recommendation to buy, sell or hold a stock. But there are subtle nuances to each term, which can convey an analyst's opinion on the returns expected or risks attached to a stock.
To start with, analysts may use different terms to convey the same view on a stock. Therefore, an `accumulate' rating on a stock often means the same as a `buy'. A `book profits' suggestion means the same as a simple `sell'. A `book profits' is usually suggested in the place of a sell, when the analyst has already recommended buying at a lower price and the stock has run up subsequently, leaving you with profits. In contrast, a `cut losses' recommendation could be an admission of guilt! The message it sends out is that the earlier `buy' recommendation has not worked and you had better exit while the going is good!
Standard terminology
A `reduce' recommendation asks you to trim your exposure to a specific stock in your portfolio; it is generally a milder form of an unequivocal `sell' (which means that the stock is expected to drop like a stone). Every brokerage or advisory house usually adopts standard terminology to convey its views on stocks and sectors and this is applied uniformly across the stocks and sectors that it covers. A basic `buy', `sell' or `hold' recommendation conveys whether the analyst expects the stock to rise, fall or trade sideways from its current price. A stock may appreciate 15 per cent from a price at which you bought it; but will you be happy with the pick, if the Sensex rises by 20 per cent over the same period? Maybe not. If you own a portfolio of stocks, you would probably like most of your stocks to do better than the market. This is why ratings such as `outperformer', `overweight' or `neutral' are used to add on another layer of information for those who own an entire portfolio — they talk about the stock's performance relative to the market as a whole. An `outperformer' rating on a stock or sector conveys the view that the stock or sector will do better than the market in future. Similarly, an `underperformer' rating suggests that the stock may lag the market.
Do note that you could lose money on a stock that is an `outperformer', as the rating does not convey absolute returns.
If the Sensex slides by 16 per cent over a month, a stock that was battered by only 14 per cent would be an `outperformer'... but you would not have made any money on it! Similarly, `overweight' or `underweight' ratings tell you about the exposure that you should take to a specific stock or sector in your portfolio, relative to an index.
`Neutral' rating
If an analyst puts an `overweight' rating on Reliance Industries, he is asking you to take a larger exposure in the stock than it has in the benchmark. You could probably choose to invest 15 per cent of your money in the stock, though it has only an 11.5 per cent weight in the Sensex basket.
If recommendations such as `outperformer' and `overweight' convey a strong positive view on a stock, a `neutral' rating can mean several things. In the strict sense of the term, a `neutral' rating is an indication that, though the analyst in not wildly enthusiastic about the company's prospects, he believes that it will perform in line with the markets; therefore the stock is worth holding. However, a `neutral' rating can also convey that an analyst has turned ambiguous about the company's prospects.
`Neutral', in some cases, could also be a euphemism for an outright sell recommendation! To interpret a neutral rating, it may be best to check the ratings on the stock before the latest recommendation. It is a negative sign if the view on the stock has turned from a `buy' to a neutral and a positive one if the view has turned from `sell' to `neutral'.
We hope we've covered the whole gamut of investment terms that you've come across while researching stocks. Hope this helps you navigate the minefield of stock market investments better!