What do analyst ratings mean? Buy, hold, sell and overweight
Most ratings you see in the news come from sell-side analysts: researchers at brokerages and investment banks who publish reports on the companies they cover. Every firm uses its own words, but they fall into three groups. Buy, outperform and overweight are positive; hold, neutral and equal-weight are neutral; sell, underperform and underweight are negative.
Overweight usually means the analyst expects the stock to do better than a benchmark, such as its sector or the other stocks the analyst covers, over the rating’s time horizon. It does not tell you how much of your money to put in it. The labels differ from firm to firm, which is why FINRA Rule 2241 requires each research report to define its ratings, including the time horizon and the benchmark, and to show what percentage of the firm’s ratings are buy, hold and sell.
- Analyst rating
- A research firm’s published view on a stock, such as buy, hold or sell, or overweight, equal-weight or underweight, measured against a benchmark over a stated time horizon.
- Sell-side analyst
- A researcher at a brokerage or investment bank who publishes reports, ratings and price targets on companies. Buy-side analysts work for fund managers and usually do not publish.
- Overweight rating
- A positive rating meaning the analyst expects the stock to do better than its benchmark, often the sector or the analyst’s coverage list, over the rating’s time horizon.
How is a price target calculated? A worked example
The most common method multiplies a forward earnings estimate by a valuation multiple, the same idea as the P/E ratio turned around. The drawing at the top of the page shows hypothetical XYZ in three steps:
- Estimate earnings: the analyst expects earnings per share of $5.00 over the next 12 months, the forward EPS.
- Choose a multiple: based on XYZ’s own history, its peers and its growth, the analyst decides the market should pay 24 times earnings.
- Multiply: $5.00 × 24 = $120. With the stock at $100, the implied upside is $120 ÷ $100 − 1 = 20%.
- Price target
- The price an analyst thinks a stock could reach within a stated period, usually 12 months, often calculated as forward EPS × a valuation multiple.
- Forward EPS
- Earnings per share expected over the next 12 months or the next fiscal year, an estimate rather than a reported number.
Why do analysts’ price targets differ so much?
A target rests on two guesses, and small changes in either one move the result a lot. In the drawing below, the stock is still $100. If forward EPS is 10% lower or higher, $4.50 or $5.50, and the multiple is 4 points lower or higher, 20 or 28, the target can be anything from $4.50 × 20 = $90 to $5.50 × 28 = $154, a $64 range from the same company.
Some analysts use other methods, such as a discounted cash flow model or EV/EBITDA for companies with little profit, and these rest on assumptions too. FINRA requires a research report to explain the valuation method behind a target and the risks that could stop it from being reached, so the report itself tells you which assumptions to question.
What is the consensus price target?
The consensus price target is the average, sometimes the median, of the targets published by every analyst who covers the stock. It works like the consensus estimate for earnings. In the drawing below, eight hypothetical analysts on XYZ set targets of $90, $100, $105, $110, $115, $120, $125 and $150. The average is $915 ÷ 8 = $114.38, 14.4% above today’s price; the median, the middle of the sorted list, is $112.50.
Look at the spread as well as the average. Here the high is $150 and the low is $90, a $60 gap, and a single outlier pulls the average above the median. A wide spread means the analysts disagree about the business, and data sites may show different consensus figures because they collect different analysts or drop old targets at different times.
- Consensus price target
- The average or median of all published analyst price targets for a stock. Data providers collect different analysts, so their figures can differ.
Why do upgrades and downgrades move stock prices?
An upgrade moves a rating up, for example from hold to buy; a downgrade moves it down. A change in rating or a large change in target can move a stock on the day, especially a smaller company followed by few analysts, because many investors and funds read the same reports at the same time. The SEC notes that the mere mention of a company by a popular analyst can move its price, even when nothing about the business has changed.
Rating changes often come right after an earnings report or company guidance, so the price reaction mixes the news and the analyst’s opinion of it. A stock can also rise or fall against a rating change. A downgrade after a long rally may only confirm what the price has already done, and an upgrade does not make a stock cheap; check the valuation ratios yourself.
- Upgrade and downgrade
- A change in an analyst’s rating: up, for example from hold to buy, or down, for example from buy to hold. Changing only the price target is not an upgrade or a downgrade.
Can you trust analyst ratings? Conflicts of interest and limits
Sell-side analysts work for firms that may also do investment banking for the companies they cover, trade their shares or own them. US rules limit and disclose these conflicts. Under FINRA Rule 2241, a research report must say, among other things, whether the firm managed a public offering for the company in the past 12 months or expects banking fees from it, whether the firm owns 1% or more of the company’s shares, and whether the analyst owns the stock. The firm must also show the share of its ratings that are buy, hold or sell, and the share of each group that are banking clients.
When a report includes a rating or target, the firm generally has to show a price chart with the dates its ratings and targets changed, so you can see its record on that stock. Research is also restricted for a set period after offerings the firm helped sell. None of this makes a rating right. A target is an opinion built on estimates, and the SEC’s guidance is not to rely on an analyst’s recommendation alone when deciding whether to buy, hold or sell.
How to use analyst ratings and price targets
Treat a rating as one input you can check, not as an instruction:
- Read the reasoning, not the headline: which EPS estimate and which multiple make the target, and which risks the analyst lists.
- Compare the forward EPS with the company’s guidance and its last few quarters of earnings per share.
- Look at the spread of targets, not just the consensus, and at how recently each target was set.
- Check the disclosures: banking relationships, the firm’s rating distribution and its price chart for the stock.
- Look at what insiders are doing as a separate signal; see insider buying.
- Decide your own entry, stop and size from your trading plan, whatever the rating says.