Stock market ratings are a multilevel recommendation system based on fact and the opinion of a securities or financial analyst. Although they can be a valuable source of information, the multitude of firms issuing ratings, differing ratings methodologies and a lack of standard terminology make it critical that you understand how to read and accurately interpret the information they provide. Once you understand the specific methodologies and terminology of ratings agencies that interest you, stock market ratings can become part of your portfolio management strategy.
Ratings System Basics
Analysts follow a daily rating system using words or symbols to define three to five ratings tiers. Although the amount and type of specific criteria differ among rating agencies, the process is similar. In general, rating agencies start the process by looking at the current market price of a share of stock. Each then employs rating criteria such as an estimate of sustainability, the credit rating of the company and competition within the industry to determine whether the current price is a fair value. Finally, the analyst expresses an opinion about the stock by recommending the stock with a positive, neutral or negative rating.
Higher level, positive ratings are a recommendation to buy. Analysts consider stocks in the highest one to two tiers to be performing above market expectations. Midlevel, neutral ratings are in general a recommendation to hold, although, according to the Financial Industry Regulatory Authority, this rating could also be a “sell” rating in disguise. Lower level, negative ratings are always a recommendation to sell.
Review stock market ratings from a number of different agencies. Get this information at the website of any agency that interests you or from a site, such as Market Watch, that summarizes ratings systems. Familiarize yourself with the tiers and terminology or symbols each agency uses to describe ratings tiers. Expect variety, especially in the area of terminology. Rating terminology may include “buy,” “hold” and “sell” at one firm, while another uses “outperform,” “neutral” and “underperform” to mean essentially the same thing. Others may include additional, in-between ratings such as “buy,” “add,” “hold,” “reduce” and “sell.” If the firm uses symbols, such as stars, the more stars a stock has, the better it is.
Read and Define
Read each rating definition to fully understand what the rating means. Look especially at time frame and any percentages the definition offers. Understand that while some will be more specific, others will offer more general recommendations. As an example, one firm may state it expects a stock with a positive rating to appreciate 15 to 25 percent or more over the next six months, while another may simply state that it expects the stock to outperform over the next 12 to 18 months. A stock with a neutral rating can have an expectation of anywhere from zero to 10 percent growth within the next 12 months to an expectation of performing at the market level with no time frame. While stocks with negative ratings have a general expectation of underperforming, some give a percentage, such as by 10 percent, while others state this in more general terms, such as “stock projected to perform significantly below the market” with no mention of time.
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