What Is Underperform?
Let me explain what underperform means in the world of investments. If you're looking at an investment that's underperforming, it's simply not keeping up with other securities. For instance, in a rising market, a stock is underperforming if its gains aren't equal to or greater than the advance in the S&P 500 Index. In a down market, if a stock is dropping faster than the broader market, that's underperformance too. You should also know that 'underperform' is an analyst recommendation for a stock expected to do slightly worse than the market return. It's often referred to as a 'moderate sell' or 'weak hold.'
Key Takeaways
- An underperforming stock isn't keeping pace with the broader market.
- The underperform rating can mean different things depending on the brokerage firm; it's sometimes called a weak hold or moderate sell.
- An analyst assigns an underperform rating when a stock isn't expected to match the market, but the issues don't call for a full sell rating.
- Stocks get this rating for various reasons, usually from comparing company metrics to peers or the overall market.
Understanding the Underperform Designation
I want to make sure you understand how this designation works, as definitions can vary between brokerages. Generally, an 'underperform' rating is worse than 'neutral' but better than 'sell' or 'strong sell.' A neutral rating means the stock should match the broader market's results. Underperform suggests the stock will perform slightly below average: bigger losses in a down market and smaller gains in an up market. A sell rating is for stocks expected to lose value, and strong sell is for those in serious trouble with potential big losses.
A security gets labeled underperform if it doesn't meet or beat a comparison metric, whether that's the overall market, a competitor, or an index. Other factors could include high debt levels, unfavorable price-to-earnings ratios, or losing market share.
Examples of Underperform Rating
Let's look at some examples to clarify this. An entire industry might be called underperforming. Take the utilities sector: economic growth could help it, but inflation leading to higher interest rates would hurt it. Or consider real estate: low interest rates might boost Real Estate Investment Trusts, but rising rates could reverse that, leading to underperformance against full potential.
For a specific stock, an analyst might give an underperform rating if there are concerns it won't match others, but not enough to recommend selling. Say a company reports growth or positive earnings, but those aren't as strong as the market's. If an auto manufacturer has a 12% total return for the year while the S&P 500 hits 23%, that could earn it an underperform label.
Keep in mind that brokerages differ in their ratings. At Charles Schwab, for example, underperform comes with sell guidance. A 'strongly underperform' from them also means sell, indicating the stock won't meet benchmarks.
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