An "overweight" rating on a stock indicates that a Wall Street analyst believes that the stock is above average compared to the full range of available stocks tracked under a benchmark index like the S&P 500. By giving an overweight rating, the analyst expresses the opinion that the stock's expected performance will be positive, and deserves a larger position than the specific benchmark gives it. Many investors see an overweight rating as indicating better value, but in some cases, analysts only intend the rating as the basis for a short-term trade.
The true meaning of an overweight stock rating
In order to put an overweight rating in context, it's important to understand the way that various stock-market benchmarks put weightings on stocks. The S&P 500, and most other popular stock-market indexes, are weighted by market capitalization. This means that the stocks with the largest market caps have the highest weightings in the index, while those companies that have smaller market caps don't have as much influence in the benchmark. The individual stocks and their weightings are incorporated into the final index value.
As a result, it's critically important in assessing an overweight rating to know which benchmark the analyst is using as a baseline. For example, the largest company in the S&P 500 has a weighting of about 2.9%, which is far larger than the average 0.2% weighting for the 500 stocks in the index. Therefore, an overweight rating would add even more of a positive imbalance to that stock's already high weighting. By contrast, the smallest companies in the S&P 500 have weightings of as little as 0.01%, so an overweight rating there wouldn't necessarily have a particularly large impact on performance compared to the overall benchmark.
The vagueness of overweight ratings
One criticism of overweight ratings is that they don't typically say exactly how much more you should add to a particular position. Again, with large positions, even a modest overweighting can have a dramatic impact on the return of your portfolio compared to a benchmark. For smaller stocks, however, it takes a substantial overweight position to have any significant influence at all on your returns.
For the most part, an overweight rating indicates less about the literal meaning of giving a stock higher weight than a given benchmark. Instead, it's typically used as Wall Street jargon to indicate a positive attitude about a particular stock. Nevertheless, before you give too much weight to an overweight rating, make sure you understand the full story that the analyst has to tell in justifying it.
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