How does anyone make decisions when the outcomes are unknown? Whether you know it or not, you apply probabilities. How accurately you estimate those probabilities will depend on how informed your decision-making will be. And the best decisions are always the ones that are informed.
Often, you outsource the estimation to ‘experts’ that you trust. Simply because you can’t have the bandwidth or the know-how to research and test every parameter that factors in. For example, when you want to buy a new phone, you may go on YouTube and see what the tech experts have to say about the phone you’re planning to buy. Or when a friend suggests a new restaurant for Sunday brunch, you may go look it up on Zomato to see its ratings and reviews. Investments, such as stocks, too, have experts reviewing them to help you make informed decisions. These experts are called analysts and their recommendations are called analyst ratings.
What is an analyst rating?
Markets are known to be volatile. All investors know that nobody can predict with 100% guarantee the direction in which a stock will move. So, how have investors been making investment decisions throughout history? By making educated guesses. And the most reliable of these educated guesses may just be that of analysts.
An analyst measures the expected performance of a particular stock for a given period of time and rates it to issue recommendations to investors. Analysts typically dive deep into the company’s financial fundamentals such as their financial statements. They may also interact with the company’s executives and customers to understand and predict the performance of the company.
Analysts usually work with brokerage firms, private banks, analysis companies, and investment firms. The analyst ratings are typically issued four times a year at three-month intervals.
How do analysts arrive at ratings?
Different analysts have different approaches in how they evaluate and come to conclusions on various stocks. But here are a few things most analysts do to arrive at analyst ratings:
- Study and analyse the company’s financial statements, business model, suppliers, competitors and other economic fundamentals.
- Get directly in touch with the management and attend the company’s quarterly calls to review the management discussions and commentary about the current and expected performance of the company.
- Conduct research and surveys to gain insight into the prospects of the company regarding earnings, market share, customer outlook, and more.
- Compare and analyse the company’s performance with its past performance as well as that of the competitors and nature of the given industry.
Based on all this research and analysis, analysts release in-depth research reports with the price estimates and stock predictions for the upcoming quarters.
What are the types of analyst ratings?
Understanding the different types of analyst ratings will help you read and use the ratings issued by analysts to make important investment decisions.
Here is a list of some of the most basic and relevant analyst ratings:
- Buy
When analysts believe that a stock is going to do well in the short-term or mid-term by say for example 15 to 20% in terms of absolute returns, they issue a ‘buy’ rating. Analysts may also issue a ‘strong buy’ rating when they are extremely optimistic about the stock’s growth.
- Sell
The ‘sell’ rating is basically the opposite of the buy rating. When analysts think that there is going to be a downward trend either due to the specific company or because of the industry in general, they issue a sell rating. Here too, there can be a ‘strong sell’ rating.
- Hold
A ‘hold’ rating signifies that investors should neither buy nor sell more of the same stock. This is because analysts think that the stock is going to perform in-line with the given market conditions or in the same way the stocks of other companies in the same industry.
- Outperform
An ‘outperform’ analyst rating conveys that the stock is expected to perform better than the current industry or market average.
- Underperform
In contrast to the outperform analyst rating, ‘underperform’ indicates that a stock may perform below the current industry or market average.
Stay updated with analyst ratings, but do your due diligence.
Analyst ratings are good indicators of the market. However, making all your investment decisions solely based on analyst ratings is not financially sound.
Even when looking at which analyst ratings to go on, you must do a little background check. Look at the credentials and qualifications of the analyst. Evaluate how often their predictions have been proven accurate and more importantly, inaccurate. Also, make sure to see whether they are an in-house analyst of a specific company that may have vested interests or are independent analysts.
A balance of your research and understanding about the markets as well as considering analyst ratings is prudent when making important investment decisions. The best analyst research and reports are often hard to find and often behind paywalls. However, you get access to a handpicked curation of world-class up-to-date analyst reports and research on the Appreciate app.
