If you trade individual stocks there is some terminology you need to know.
Bull and bear markets refer to rising and falling stock prices, respectively. A “dead cat bounce” happens when a stock regains a small amount of value in the middle of an otherwise steady decline. Indexing occurs when traders have built their portfolio around a specific metric, such as a mutual fund “indexed” to the S&P 500.
Then there is “overweight” and “underweight.” Analysts use these terms to describe how they think individual stocks will perform relative to the market. Here’s what you need to know.
What Does Overweight Mean? Underweight?
Overweight and underweight are performance predictions. It’s an indication of how analysts think the stock will do in the foreseeable future. Typically an overweight/underweight designation refers to performance over the next 12 months.
Overweight is a buy recommendation that analysts give to specific stocks. It means that they think the stock will do well over the next 12 months. This can mean increasing in value or just not losing as much value, depending on market conditions, but it always means that the analyst believes the stock will outperform its market. They can define this by any given benchmark. For example, this could mean that the analyst thinks the stock will do better than its industry, or the analyst could believe that the stock will outperform the S&P 500.
The term “overweight” is perhaps better written as “over-weight.” It’s an instruction. The analyst thinks that investors should weight this stock more heavily in their portfolios or funds.
Underweight is a sell or don’t buy recommendation that analysts give to specific stocks. It means that they think the stock will perform poorly over the next 12 months. This can mean either losing value or growing slowly, depending on market conditions, but it always means that the analyst believes the stock will underperform its market.
Similar to overweight, the term “underweight” can be better understood as “under-weight.” This is a recommendation for investors to weight this stock less heavily in their portfolios or funds.
Examples of Overweight/Underweight Recommendations
Say that ABC Co. is a retail company. They receive an “overweight” analysis. This means two things:
- First, the analyst who wrote this believes that ABC Co. will do better than the retail sector in general, and perhaps even the stock market as a whole. This could mean that ABC Co. will have strong gains, but in a weak market it could mean that the company will grow less slowly than its competitors. During a market downturn, it could even mean that ABC Co. will simply lose less value than comparable investments.
- Second, the analyst who wrote this believes that investors who hold retail stocks should increase their holdings of ABC Co. stocks. They should over-weight this particular stock in their portfolio relative to other, comparable investments.
Suppose, however, that ABC Co. received an “underweight” analysis. This would mean two things as well:
- First, the analyst who wrote this believes that ABC Co. will not do as well as comparable investments. ABC Co. might be poised to grow more slowly, or even to take greater losses, relative to other retail stocks or the market as a whole.
- Second, the analyst who wrote this believes that investors who hold retail stocks should decrease their holdings of ABC Co. stocks. They should under-weight this particular stock in their portfolio relative to other, comparable investments.
Overweight/Underweight vs. Buy/Sell
Why don’t analysts just recommend “Buy” or “Sell” instead of inventing terminology that sounds like a trip to the gym?
In part, this is because analysts have grown more reluctant to explicitly recommend purchases to clients. Many stock market analysts now feel like they shouldn’t take responsibility for a client’s decisions. They see their role as offering market perspective, while leaving action decisions (such as whether to buy or sell a stock) up to the client. “Overweight” lets them say, essentially, “I think a retail-oriented portfolio should over-weight ABC, Co. Do with that information what you like.”
However, "buy" and "sell" are also slightly different pieces of information. When an analyst calls a stock overweight or underweight, they’re making a recommendation against diversity. They’re saying that portfolios should consider reducing diversification in favor of, or away from, this particular stock based on its likely performance.
When an analyst lists a stock as “overweight,” they aren’t necessarily saying that any given investor should buy it. They’re specifically saying that a portfolio with similarly-situated investments should consider making this stock a more prominent part of that bundle of assets. From our example above, if your portfolio contains retail stocks, you should consider making ABC Co. a larger percentage of those retail holdings.
That’s not the same thing as saying that anyone should buy, though. For example, an investor who doesn’t hold any retail industry stocks might not get much value from ABC Co. The analyst thinks the stock will generally do well compared to some other stocks, but that doesn’t necessarily mean it’s worth changing your investment strategy around.
The same goes for “underweight.” This means that the stock will generally underperform its related market or index. An investor who holds this stock should consider reducing its role in their portfolio, because it’s likely to do more poorly than comparable investments.
That doesn’t necessarily mean that an investor should sell it, though. Someone who holds this stock to diversify industries altogether, for example, might still get some value by keeping this stock. The analyst thinks the stock will underperform some other stocks, but again that doesn’t mean you should change your investment strategy altogether.