If you have ever read a research report from an equity analyst, you may have come across stocks described as being “overweight.” This doesn’t mean that the stock needs to cut carbs and join a gym. In fact, being labeled “overweight” is actually good for a stock.
However, overweight is certainly a confusing term. Most investors are used to seeing more straightforward buy or sell recommendations. Usually, if an equity analyst recommends a stock as overweight, he or she thinks that the stock will do well going forward and that it's worth buying right now
What does it mean when a stock is overweight?
Overweight is a buy rating that equity analysts give to certain stocks. It means that the analyst thinks that the stock will perform well over the next 12 months. The stock could grow in value or not lose as much value based on market conditions. An overweight rating often means that the analyst thinks the stock could outperform the other stocks in its sector or the broader market.
In contrast, an underweight recommendation means the analyst thinks that the stock's future performance could be poor. It's a sell or don’t buy rating that the analyst gives to certain stocks. It means that the analyst thinks that the stock will perform poorly over the next 6–12 months. This can mean that the stock reduces in value or simply grows slowly based on market conditions. An underweight recommendation often means that the analyst thinks the stock could underperform the other stocks in its sector or the broader market.
Five-tier and three-tier rating systems
Let’s explore the rating system to understand where “underweight” and “overweight” fit in. Investors are accustomed to the three-tiered rating system of “buy,” “hold,” and “sell.” The three-tier system provides advice on what you should do with a stock.
Not every research firm uses the same terminology. Some firms use a five-tiered rating system instead of three. Some firms don’t use “overweight.” They use terms like “accumulate,” “outperform,” or “add.” Instead of “underweight,” they may use “reduce,” “underperform,” or “weak-hold.” There aren't any rules that govern how research firms issue recommendations, so it helps to familiarize yourself with each firm's system.
Usually, an “overweight” rating is nestled in between “buy” and “hold” on a five-tiered rating system. In other words, the firm likes the stock, but a “buy” recommendation indicates a stronger endorsement.
Some firms will use “underweight” and “overweight” in reference to sectors in place of specific stocks. For example, they may issue a report recommending that the healthcare sector is “overweight,” which suggests that the healthcare sector will outperform the overall market.
How do you determine stocks' weight?
It would be helpful to measure the weight of the stocks you own for your investing plan. For example, if your investment objective is to allocate no more than 15 percent of your portfolio to any particular stock, calculating the weight of the stocks in your portfolio can let you know whether or not you need to make any adjustments. Here’s how you calculate the weight of stocks.
Weight = (Stock’s value / Total portfolio value) x 100
You should never buy or sell a particular stock based on a single opinion, especially since analysts often disagree. For each stock, there will be numerous people providing opinions on whether it’s a good investment or not.