Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Stock ratings: How dependable? - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Aug 16, 2004

    Stock ratings: How dependable?

    Benjamin Graham says, '...in the short term, the market is a 'voting' machine whereon countless individuals register choices that are product partly of reason and partly of emotion. However, in the long-term, the market is a 'weighing' machine on which the value of each issue (business) is recorded by an exact and impersonal mechanism.'

    It has always proved to be a challenge when it comes to determining the ‘right’ price of a stock. The complication arises because stock prices are not only a factor of historical track record of a company, but also ‘expected’ earnings growth in the future. But when it comes to ‘expectations’, there is a great deal of analysis involved (subjective and quantitative). Economic growth projections of various research agencies are one classic example.

    Expectations vary person and person (individual investors, research houses, institutional investors, technical analyst, traders and so on) and this is what makes the stock market very interesting and at times, complicated. Given the complexities involved, how do individual investors take investment decisions?

    Apart from a few set of investor who depend on their own assessment, investment decisions are taken based on what brokerages/research houses recommend. The recommendation could be a broader sectoral view (i.e. whether the cement sector looks promising) or what should an investor do about a stock (say, Tisco)?

    Therein lies another complication. There are no universal standards when it comes to stock recommendations. While some brokerages follow the traditional Buy-Sell way, there are some who recommend stocks with an Overweight-Underweight-Neutral strategy. In this article, we try and simplify some of these ratings for You, the individual investor! But one extremely critical factor that we have not focused on is the rationale behind these recommendations, which needs utmost questioning. We limit ourselves to only the ratings part in this article.

    Buy – Sell – Hold

    Generally, a stock is recommended a Buy when it is expected to give a return, say around 15% per annum and a Sell if the upside from the date of recommendation is, say less than 10%. Hold is generally for those stocks, which have been already recommended by the brokerage. But again, the standards are not common for all.

    Out-performer – Under performer – Market performer

    In the institutional and the fund management side of the equity market, what is more important is the relative performance to the benchmark index. Simply put, if a Fund X benchmarks itself against the BSE Sensex, the fund manager focuses on bettering the index (i.e. Rs 100 in his fund should yield more than Rs 100 invested in the BSE Sensex). The rationale is simple. Why would an investor buy the Fund X (with a entry or exit load) when it is expected to perform like the BSE Sensex (index funds usually charge lower load as compared to let’s say, a diversified fund)?

    So, if a brokerage puts out a Out-performer rating on a stock, generally, the stock is expected to outperform the benchmark index by around 10%-15% (varies across the board). Here, one critical factor needs to be understood. If a brokerage expects the stock market to fall by say 10% and recommends an out-performer rating on a stock, even if the stock falls by 5% in the similar period, it has still out-performed the index!

    Under-performer is recommended when the stock is expected to appreciate/depreciate lower than the benchmark index and Market performer is one where a stock is likely to track the index performance. In these kinds of recommendations, the view on the stock is as important as the view on the stock market as a whole.

    Overweight – Underweight – Equal Weight

    Sounds like a report card from a weighing machine in the local railway station! This is actually a fund management strategy. In order to outperform the benchmark index, the fund house needs to a different stance as compared to the market. In the BSE 30 for instance, if the software sector has a 15% weightage (i.e. the combined market capitalisation of software stocks in the BSE 30 divided by the total BSE-30 market capitalisation) and if a brokerage is overweight on this sector (more positive), the sum invested in software stocks could be higher than the overall benchmark index. Thus, it expects to outperform the benchmark index.

    In the 2000 tech boom, a number of funds were overweight on software stocks only realising later that weight loss is the only way out of the mess! From an individual investor perspective, a whole host of factors needs to be understood and we suggest not following such a strategy. Individual investor’s risk-return profile and a risk-return profile of a group of investors (which is what a mutual fund is) are different in most cases.

    Attractive – In-line – Cautious

    Mostly, these recommendations are sectoral or for the economy as a whole. If a brokerage believes that the cement sector looks good from a long-term perspective and the stocks are likely to outperform the broader benchmark (say the BSE Sensex), it recommends an Attractive rating. If it is not, then it takes a cautious stand. Since these recommendations also involve relative benchmarks, from an individual investor perspective, the complications increase.

    Common sense matters the most…

    Before you take an investment decision based on the news of a recommendation by a brokerage, it is important to understand one’s own risk-return profile i.e. how much am I willing to forgo? This will determine your rating and the investment style.

    The word ‘strategy’ sounds exciting but has its own limitations. There have been instances of a brokerage changing its rating style each year in the past. If you have a copy of a research report, we suggest you to read the finer print. If you do not have a copy (most of the times, inaccessible to individual investors), atleast understand the rationale behind the recommendation. One day here and there will not make a much difference to the final outcome of the investment decision, if one is looking to build a viable portfolio of investments that is dividend paying and gives capital appreciation along the way. Following the herd is not the sure shot way of improving one’s own financial rating!



    Equitymaster requests your view! Post a comment on "Stock ratings: How dependable?". Click here!


    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    Dear PM Modi, India is Already Land of Self-Employed, and It Ain't Working (Vivek Kaul's Diary)

    Aug 21, 2017

    Most Indians who cannot find jobs, look at becoming self-employed.

    The Key Factor Pushing Gold Up These Days (Outside View)

    Aug 21, 2017

    PersonalFN explains the chief factor pushing gold prices up of late.

    How Unique Are the Companies You Invest In? (The 5 Minute Wrapup)

    Aug 21, 2017

    One of the hallmarks of successful investing is to look out for companies that have a unique and enduring moat.

    You've Heard of Timeless Books... Ever Heard of Timeless Stocks? (The 5 Minute Wrapup)

    Aug 19, 2017

    Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.

    More Views on News

    Most Popular

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    The Most Profitable Investment in the History of the World(Vivek Kaul's Diary)

    Aug 8, 2017

    'Yes, it looks like a bubble. And, yes, it's like buying a lottery ticket. But there's something happening that has never happened before. It's an evolutionary leap in money itself.'

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    Bitcoin Continues Stellar Rise(Chart Of The Day)

    Aug 10, 2017

    Bitcoin hits an all-time high, is there more upside left?

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms


    Aug 21, 2017 (Close)