When it comes to stocks, there are all sorts of different terms that you need to be familiar with in order to make informed investment decisions. One term you may have heard but aren't quite sure about is underweight.
We will break down the definition of underweight and discuss what it means for investors. We'll also explore whether or not an underweight stock is a good thing and offer some advice on how to weigh the pros and cons of investing in one.
What does underweight mean in the stock market?
Underweight is a common rating attributed to stocks by analysts that means that the stock is expected to underperform the broader market. Although this is the most common use for the expression it can also be used to describe a portfolio where a certain holding is underweight, meaning that the portfolio does not have the same exposure as its benchmark.
What does it mean when a stock is overweight or underweight?
In simple terms, overweight and underweight refer to the expected returns of a particular stock, or it can also relate to the number of investors that are invested in the stock.
In terms of returns, an overweight stock is often a stock rating proposed by analysts that expect the stock to beat its benchmark. Conversely, an underweight rating is used for stocks that are expected to underperform.
Does underweight mean sell?
The term "underweight" does not necessarily mean that you should sell your shares. Instead, it is simply a way to describe that the expected returns for the stock in the short term can be lower than its benchmark.
Although an underweight rating can be compared to a sell rating it is actually quite different. When a financial analyst categorizes a stock as a sell it is recommended that investors sell that particular security. Underweight on the other hand just means that the short-term returns are expected to lag the broader market or its benchmark.
What does underweight mean in investing?
When it comes to investing, and portfolio management, underweight means that the exposure to a particular stock is being reduced in comparison with the index or the benchmark you are trying to beat. This can be seen as a good thing or a bad thing depending on the investor's goals and risk tolerance.
Is an underweight stock good?
An underweight stock is one that analysts expect to underperform relative to its benchmark, and although it is not a recommendation to sell the stock, investors should be aware that it is likely that the stock will underperform.
While some investors are looking for stocks that can move higher in the short-term, other investors with a longer investment horizon will look at stocks that can underperform in the short term. Some of these investors include value investors and contrarians, that have the necessary patience to hold some stocks, while their trends reverse.
Pros and Cons of Investing in an Underweight Stock
If you're considering investing in an underweight stock, it's important to weigh the pros and cons before making a decision. Some of the key pros include:
Viewed as a bargain
Since there are more sellers than buyers an underweight stock may be viewed as a bargain. This can be especially true if the stock has been underperforming in recent months. If analysts believe it is underweight for trivial reasons such as market volatility, this can provide an opportunity to buy the stock at a discount.
When there are more buyers than sellers, it can be difficult to find shares to buy. This is not the case with an underweight stock. Because there are more sellers, it can be easier to find shares to buy.
On the other hand, some of the key cons to consider include:
More downside risk
An underweight stock may have more downside risk since there are more sellers than buyers. This is because the stock may be more volatile and prone to sell-offs.
There could be a reason for being underweight
There could be a fundamental reason why the stock is underweight. For example, the company may be struggling financially or facing negative news headlines. If this is the case, it's important to do your research to determine if the stock is a good investment.
There may be less demand for an underweight stock, which could make it more difficult to find a buyer when you're ready to sell.
Can be volatile
Underweight stocks can be more volatile than other stocks since there is less demand for them. A whale can move the price of an underweight stock more easily than it could with a non-underweight stock. This is because they can acquire more shares at a cheaper price since there are more sellers.
All things considered, there are both pros and cons to investing in an underweight stock. It's important to do your research and weigh the risks and rewards before making a decision.
When it comes to stocks, being overweight or underweight can have different meanings. Overweight means that a stock is doing better than stocks in its sector, while underweight means that a stock is not doing as well.
Being overweight or underweight does not necessarily mean that you should buy or sell a stock. However, if a stock is overweight, it may be a good idea to hold onto the stock, and if a stock is underweight, it may be a good idea to reevaluate your investment thesis.
These weightings are given by analysts to give you an idea of how a stock is doing in comparison to others. They can help you determine the adequate position size for your portfolio, but at the end of the trading day, it's up to you to decide for yourself.