What It Means for a Stock to Be Overweight
No, it does not mean that the stock needs to hit the treadmill
If you’ve ever read a report from an investment analyst, you may have seen stocks described as “overweight.”
This does not mean that the stock needs to cut the carbs and hit the gym. In fact, it’s actually good for a stock to be labeled as “overweight.”
But it’s definitely a confusing term, especially given that most investors are accustomed to seeing more straightforward “buy” or “sell” ratings.
Basically, if an analyst rates a stock as “overweight,” he or she thinks that the stock will perform well in the future, and believes it is worth buying—it could outperform the broader market and other stocks in its sector. On the flip side, an “underweight” rating means the analyst thinks future performance will be poor. Usually, the rating refers to predicted performance over the next 6-12 months.
One can view “overweight” and “underweight” as being synonyms to “buy” and “sell,” but there’s a little more to it than that. Let’s first examine the rating system to understand where “overweight” and “underweight” fit in.
Three- and Five-Tier Rating Systems
First, it's probably worth explaining what analysts actually do. Stock analysts are employed by investment firms to perform research on investments and issue recommendations. Usually, these recommendations come in the form of a rating.
Investors may be most familiar with the three-tiered rating system of “buy,” “sell,” and “hold.” Those are easy to remember because they offer guidance on what an investor should do with a stock.
Not every firm uses the same terminology, and some use systems with five tiers instead of three. Some analysts don’t use “overweight” at all, but use terms like “outperform” “add” or “accumulate.” Instead of “underweight,” they may use “underperform,” “reduce” or “weak-hold.” There are no rules dictating how companies issue ratings, so it helps to familiarize yourself with each company's system.
In general, “overweight” is nestled in between “hold” and “buy” on a five-tier rating system. In other words, the analyst likes the stock, but a “buy” rating suggests a stronger endorsement.
But wait! It gets even more confusing. Some firms use a three-tier rating of “underweight” “equal weight” and “overweight.” This is because some companies have shied away from offering explicit "buy" or "sell" recommendations. In this case, it’s fine to view “overweight” as a synonym for “buy.”
Why the Reference to Weight Is Used
You may hear “overweight” used in a different context, often relating to the makeup of an investment portfolio.
In general, your investment portfolio should be made up of a diverse mix of stocks and other investments, and you should try to avoid being too heavily invested in any one thing. When you have a good mix like this, it means that your portfolio is properly “balanced.” When your portfolio is unbalanced, it may mean that you are too heavily invested in one thing. We refer to this as being “overweight.” Similarly, if you don’t have enough of a certain investment in your portfolio, you are considered “underweight.”
So what does this have to do with analyst ratings?
Well, it’s also important to understand that stock market indexes, such as the S&P 500, are constructed based on market capitalization, with each stock getting a certain amount of “weight” in the index. So for example, in July 2020 Apple had a weighting of 5.74 percent in the S&P 500 because it is one of the world’s largest companies.
If an analyst provides an “overweight” rating on a stock, he or she is suggesting that the company should soon receive a higher “weight” in whatever index it is a part of.
Some investment firms will use “overweight” and “underweight” in reference to sectors instead of specific stocks. For example, they may issue a report suggesting that the retail sector is “overweight,” meaning that it will outperform the overall market.
None of this is particularly useful for the average individual investor, however. For most of us, it’s best to view an “overweight” rating as simply as another way of conveying a positive sentiment about a stock.
Ratings Are Just Guides
For every stock, there will be countless people offering opinions on whether it’s a good investment or not. Analyst ratings are simply one piece of information out there, to go along with past price performance, earnings reports, profit margin, and other financial information. No one should ever buy or sell a stock on the basis of a single opinion, especially since analysts often disagree. Thus, agonizing over what an analyst truly means by an “overweight” rating is not particularly useful.