So, if you don't hold this stock in your portfolio, it's a recommendation that doesn't mean a lot to you. If you do, and you choose to follow the recommendation, you'd rebalance your portfolio to have less weight on that particular stock, either by purchasing more of other stocks or by selling some of the stock.
Overweight vs. underweight
If an underweight stock is a stock that's underperforming on some metric when compared to something else, like its industry or its index, an overweight stock is a stock that's overperforming compared to whatever metric you're looking at. So, an overweight recommendation is a recommendation to rebalance your portfolio by increasing the weight of the portfolio in that stock -- not necessarily a recommendation to buy.
Sometimes, a stock can be both underweight and overweight at the same time, which can be confusing for investors. It's important to consider what the stock is being compared to to determine if it's under- or overweight and how that aligns with your investing goals. Once you determine what the weighting means for you, you can figure out if you want to rebalance or not.
What to do with underweight stocks
Let's say that you have a stock in your portfolio, ABC Inc. You've been an investor in ABC Inc. for a while, and you generally believe the company is doing well and all of its metrics are within the parameters of your investing thesis. All in all, it's performing as you expect it should.
However, you read online that ABC Inc. is an underweight stock now, and that has you questioning everything about your investing decisions, even though ABC Inc. has been performing well for you. Here's how to deal with that underweight rating:
- Ask, "Compared to what?" Figure out what the underweight rating is actually saying. Is ABC Inc. underweight compared to the S&P 500? Is it underweight compared to its industry? Is it underweight compared to companies that aren't as much like it as they may seem at first glance?
- Evaluate your investing thesis. Are you trying to beat the industry or other grouping that ABC Inc. is in across the shorter term? Or do you have ABC Inc. because you believe it has much longer-term potential, perhaps once a flagship product in development is launched? If holding ABC Inc. is still in line with your investing thesis, there may be no cause for concern.
- Decide if you want to underweight the stock. Are you happy with the performance of your portfolio? Have you checked the company's recent filings? Do you feel like ABC Inc. is a company you would want to bank your future on? Remember, a stock can be simultaneously under- and overweight, and that could be the case with your ABC Inc. holdings. The choice is yours.
- Act, or don't act. If you choose to act, you can sell some of your stock in ABC Inc. or you can simply rebalance your portfolio by adding more stocks of other types so that ABC Inc. doesn't make up such a large percentage of your portfolio. Or don't act. It's still your portfolio at the end of the day, and you are the one who will ultimately deal with the results of your decisions.
