What Does Outperform Mean?

Receiving an outperform stock rating is like getting an “A” in school…

There’s no question that an “A” is an excellent grade to get in school. In some schools, it’s the highest grade you can earn. Other schools might choose to use an “A+,” making “A” the second best grade. Either way, it’s better than most. Similarly, outperform is a solid market rating, that, depending on the brokerage firm, is either the highest or second-highest available.

Outperform is a rating granted to stocks that are expected to perform better than the rest of the market. There are many different brokerage firms that assign ratings to stocks. Depending on the firm, outperform may have different meanings.

Some firms may assign an outperform rating to any stock they expect to perform better than the market as a whole. Others have more specific meanings, such as a particular percentage in excess of market returns they expect the returns of a particular stock to be. For example, the firm Sanford Bernstein assigns the outperform rating to any stock whose returns it believes will exceed the market index by 15% or more in the coming year.

There are a few different things it could mean for a stock to outperform. First, the term outperform could refer to the rating a stock receives from analysts. An outperform rating generally means that the analyst expects the stock to perform better than the market.

But even within analyst ratings, there’s no single definition for outperform. Some analysts, such as Bear Stearns, have outperform as the highest rating a stock can get. But for other analysts, outperform is the second-best rating. It indicates that they expect a stock to perform better than the market, but perhaps not quite as well as some other individual stocks.

Outperform could also refer to a stock’s actual performance, rather than just how analysts expect it to perform. If a stock outperforms, it generally has better results than the market as a whole.

For example, suppose the S&P 500 (an index of the 500 largest publicly-traded companies, often a benchmark for the stock market’s total performance) sees average returns of 7% during a particular period. But during that same period, one specific company’s stock in the index sees returns of 10%. That stock would have outperformed in the market.

Outperform is a rating analysts give a stock when they expect it to perform better than the market as a whole. Underperform is just the opposite. Underperform is a rating that indicates analysts expect a stock to perform worse than the rest of the market.

In most cases, underperform is the worst rating a stock can receive. But different analysts have different thresholds for how much a stock is expected to underperform by to receive this rating. For some analysts, any stock they expect to perform worse than the market receives an underperform rating. Other analysts specifically give this rating to stocks they expect to underperform by a particular percent, such as 10% below the market.

Underperform could also refer to a stock’s actual performance, rather than its expected performance by analysts. Measurement of a stock’s underperformance is often in comparison to a particular benchmark — usually the S&P 500.

Many brokerage firms have a unique rating system they use to rate the expected performance of stocks. These ratings are the tools that firms use to make investment recommendations to their clients. Because each firm does things a bit differently, there’s no one set of ratings that all firms use.

Analysts use these ratings when they believe a stock will perform better than the market. Some ratings, such as the strong buy rating, mean the analysts believe a stock will perform much better than the market, or that it will outperform the market both in the short-term and the long-term. Other positive ratings might simply mean the analyst believes the stock will outperform the market. Here are some of the more common positive ratings that firms use to make stock recommendations:

• Strong buy
• Buy
• Market outperform
• Overweight

Brokerage firms generally use the following ratings for stocks they believe will perform just slightly better than the overall market, or for those they expect will perform roughly the same as the market. Here are some of the neutral ratings a firm might assign to a particular stock:

• Hold
• Neutral
• Market perform
• Sector perform
• Equal-weight

Analysts generally use these ratings to indicate that they believe a stock will perform worse than the market. These ratings don’t necessarily mean the analyst believes the stocks will decrease in value — It just means that they don’t believe they’ll increase in value as much as the overall market. Here are some of the negative ratings firms use to recommend against the purchase of a particular stock:

• Sell
• Market underperform
• Underweight
• Avoid

When analysts assign ratings to stocks, they are making an educated guess about their future performance. It’s important to remember, however, that these are forward-looking recommendations. They simply represent what analysts expect to happen to each stock.

An analyst’s prediction that a particular stock will outperform the market isn’t a guarantee that it actually will. In fact, data suggests that financial professionals and active fund managers rarely outperform the overall market. This suggests that individual stock ratings should be taken with a grain of salt.

There are also some that argue that analysts assign ratings that they don’t fully believe to be true. Analyst ratings generally indicate that they believe the vast majority of stocks will outperform the market. But suppose the stock market saw average returns of 8% during a particular year. To achieve that average, there would have to be stocks that saw returns of higher than 8%, as well as some that saw returns less than 8%. Analyst recommendations don’t necessarily reflect that mathematical reality.

Another reason for the possibly misleading ratings is that many firms that rate stocks also have a department that carries out initial public offerings (IPOs). As a result, these firms have some incentive to encourage investors to buy certain stocks.

If analyst ratings were a true prediction of market performance, one would probably expect to see as many underperform ratings as outperform. Ultimately, brokerage firms make money when people buy stocks. They also make money through IPOs, and may benefit from rating those stocks well. As a result, it’s likely in their best interest to recommend their investors buy stocks.

A rating of outperform generally means that analysts expect a stock to perform better than the overall market or better than a particular benchmark such as the S&P 500 (a market index of the 500 largest publicly-traded companies).

There are many brokerage firms that analyze stocks and assign particular ratings to them. Depending on the firm, outperform is generally either the best or second-best rating a stock can get. For some firms, outperform is a rating that simply means they expect a stock to perform better than the market. In other cases, firms assign this rating only to stocks they expect to outperform the market by a particular percentage, such as 10%.