Understanding an Underperforming Investment
If an investment is underperforming, it is not keeping pace with other securities. In a rising market, for example, a stock is underperforming if it is not experiencing gains equal to or greater than the advance in the S&P 500 Index. Conversely, in a down market, a stock that is falling faster than the broader market is also classified as an underperformer. Additionally, ‘underperform’ is an analyst recommendation assigned to a stock when shares are expected to do slightly worse than the market return. This designation can also be known as a ‘moderate sell’ or ‘weak hold.’
Key Takeaways
- An underperforming stock is not keeping pace with the broader market.
- The underperform rating can have varying meanings depending on the brokerage firms issuing the rating; it is sometimes called a weak hold or moderate sell.
- An analyst will assign an underperform rating when a stock is not expected to keep pace with the market, but the concerns do not justify a sell rating.
- Various factors, such as company debt levels or price-to-earnings ratios, can contribute to a stock receiving an underperform rating.
Delving Deeper into the Underperform Designation
The exact definitions of ‘underperform’ can vary between brokerages, but generally, a stock with this rating is considered worse than ’neutral,’ but better than ‘sell’ or ‘strong sell.’ Here’s how the ratings compare:
- Neutral: Assigned to a stock expected to deliver results that match the broader market.
- Underperform: Typically for a stock that will likely perform slightly below par, showing greater losses in a down market and below-average gains in an up market.
- Sell: Indicates a stock that is expected to lose value.
- Strong Sell: Reflects significant concerns, suggesting the company may be in deep trouble and the stock could suffer substantial losses.
A security might receive the underperform designation if it does not meet or exceed a metric it is being compared against. This comparison might be against the overall market, a competing company, or an index. Additional issues, such as concerns about the company’s debt levels, price-to-earnings ratios or loss of market share, can also trigger the underperform rating.
Examples of Underperform Ratings
An entire industry can be described as underperforming. For instance, the utilities sector might receive an underperform designation if the economic growth boosts the industry, yet inflation leads to higher interest rates, negatively impacting utilities. Similarly, the real estate market could be influenced by changing interest rates that affect investments in Real Estate Investment Trusts (REITs), warranting an underperform rating for this sector.
A specific stock might be assigned an underperform rating by an analyst if concerns exist that shares will not keep pace with others for various reasons, but these concerns do not warrant a sell rating. For example, if an automobile manufacturer reports a total return of 12% for its fiscal year, while the S&P 500 sees a 23% total return for that same year, the auto manufacturer could be classified as underperforming.
The meaning of an underperform outlook can also vary depending on the brokerage firm. Some firms may associate an underperform rating with sell guidance, emphasizing an expectation that the stocks will not meet benchmarks.
Related Terms: neutral rating, sell rating, strong sell rating, market performance, analyst recommendation.
References
- Charles Schwab. “About Schwab Equity Ratings”, Page 2.
