You've probably seen headlines on your stock broker's homepage or the financial news site you visit. "Analyst upgrades stock XYZ, raises price target." Or "Analyst trims price target on concerns over a recession."
So what does that mean? Wall Street is filled with analysts who research stocks and upgrade or downgrade them based on their opinions. Sometimes, these ratings can even move a stock's share price.
Analyst upgrades and downgrades are outside investors' control, but you can control what you do about them and how they impact your investment strategy.
Here's what you need to know.
What can upgrades and downgrades tell you?
Analyst ratings can be tricky. On the one hand, analysts are typically well-educated professionals when it comes to the stocks they cover. They often have an area of expertise, such as streaming or electric vehicles. At the same time, analysts are still just people with an opinion -- they make an educated guess about a company's prospects, and they can be wrong.
For example, you can look up analyst ratings on Tesla stock now and get a wide range of results. Currently analyst price targets range between $85 and $400, versus the current share price of $247. Consider looking at the consensus or the collective average of ratings to get a better sense of how the analyst community feels about a stock.
For Tesla, $253 is the average target price, meaning the analyst consensus sees Tesla as fairly valued. Again, analyst ratings are more opinion than fact, but seeing where the consensus lands on a stock can help investors determine how Wall Street might feel.
Why you should take them with a grain of salt
Analyst ratings can give you some interesting perspectives on market sentiment, but investors should rely on themselves to make investing decisions. Generally, there are two reasons you shouldn't let upgrades or downgrades influence your thinking too much. First, analysts frequently change their minds. Tesla's average price target is $253 right now, but look below how much it's varied over the past year alone!
Data by YCharts.
Second, most Wall Street professionals, including analysts, work on a short-term mindset. Wall Street pays close attention to a company's quarter-by-quarter performance, which is less helpful if you're a long-term investor looking years into the future to gauge a stock's potential.
In other words, price targets frequently change, which is especially problematic for someone looking to buy and hold great businesses, letting their long-term performance drive investment returns.
Using analyst ratings to your advantage
Want to know the best way upgrades and downgrades can help you invest? Seeing analysts change their price target or rating on a stock isn't necessarily the story, but why they changed it could be. Use analysts' insights to your benefit by asking why price targets are going up or down.
For example, repeated downgrades might draw your attention to something fundamentally wrong with a company that you didn't see before. Or maybe the downgrades are due to something outside the company's control like inflation. In that case, the pessimism around the stock could create a great buying opportunity for a long-term investor.
Some investors put a lot of weight into analyst upgrades and downgrades, but the truth is they're often more noise than substance for those looking further out than a few months. That said, as long as you base your buying and selling on your own due diligence, analyst ratings can still be a helpful tool in your investing process.
