Underperformed Stocks: Causes, Risks, and Strategies
RP
Summary:
If an investment is underperforming, it means it is not keeping pace with other securities. This can happen in both rising and falling markets. Analysts use the term “underperform” when they expect a stock to do slightly worse than the market return. This designation is also known as “moderate sell” or “weak hold.” Let’s delve into the concept, understand its nuances, and explore how analysts use the term.
Understanding underperformance
An underperforming stock exhibits a lack of pace compared to the broader market. Whether it’s failing to gain as much as the S&P 500 Index in a bull market or falling faster than the market in a downturn, the term applies. Analysts also assign the label when they anticipate a stock’s performance will slightly lag behind the market return. This categorization is alternatively termed “moderate sell” or “weak hold.”
Examining the underperforming designation
Rating hierarchy
The exact meaning of an “underperform” rating varies between brokerage firms. Generally, it falls worse than “neutral” but better than “sell” or “strong sell.”
- Neutral: Expecting results to match the broader market.
- Underperform: Anticipating below-par performance—greater losses in a downturn and below-average gains in an upturn.
- Sell: predicting a loss in value.
- Strong sell: reflecting deep concerns about the company’s situation and potential substantial losses.
Reasons for underperformance
A stock may receive an underperform designation due to various reasons. This could include a failure to meet metrics compared to peers, the overall market, or a competing company. Concerns about debt levels, price-to-earnings ratios, or loss of market share might also contribute.
Examples of underperforming ratings
Industry perspective
Industries, too, can be labeled as underperforming. For instance, the utilities industry might face this designation due to conflicting factors like economic growth benefiting the industry but inflation leading to higher interest rates, which is unfavorable for utilities.
Stock-specific instances
A specific stock gets an underperform rating when there are concerns about it not keeping pace with others. For example, even if a company shows growth or positive earnings, those returns might not match the market. If an automobile manufacturer reports a 12% total return for its fiscal year while the S&P 500 sees a 23% return, the auto manufacturer could be classified as underperforming.
Frequently asked questions
What does “underperform” mean in the stock market?
“Underperform” in the stock market indicates that a security is not keeping pace with other securities, either in a rising or falling market. It’s also an analyst recommendation, anticipating that the stock will perform slightly worse than the market return.
How is the underperform rating different from a sell rating?
While an underperform rating suggests a stock will perform slightly below par, a sell rating indicates an expectation of the stock losing value. Underperform is considered less severe than a sell or strong sell rating.
Why might a stock receive an underperform rating?
A stock could be labeled as underperforming due to various reasons, including not meeting metrics compared to peers, the overall market, or concerns about debt levels, price-to-earnings ratios, or loss of market share.
Key takeaways
- An underperforming stock lags behind the broader market.
- The underperform designation may vary in meaning between brokerage firms.
- Reasons for underperformance can range from industry dynamics to specific company metrics.
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