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Veena: Why are you having that confused look on your face?
Ram: I just got this report on a stock from a broker. The rating is overweight, but there is not much upside to their target price from current levels. What’s the point?
Veena: Ha! You should patiently go through the report fully and not read just the first few pages. Then you will get it. In later pages in their reports, they explain what their ratings mean. As such, there is no standardised format for sell side reports. Each use their own ratings methodology. For example, you can be positive on an absolute basis, or on a relative basis on a stock and the ratings can be Overweight/Buy/Strong Buy/ Outperform etc, but they can have different meanings.
Ram: I am more confused now!
Veena: Lol! Let me explain. If you see a few JP Morgan reports, their top rating for stocks — Overweight — is defined as expectation that the stock will outperform the average total return of stocks in the analyst’s coverage universe. And this, within a time frame of 6-12 months. Barclays’ Overweight rating too is similar, though the benchmark here is the industry coverage universe and over a 12-month horizon. So, if you see in these cases, it is more of a relative rating methodology.
On the other hand, brokerages such as Jefferies and Deutsche Bank or Dolat have an absolute rating system. Jefferies defines its buy rating as an expectation that the stock will provide a total return of 12 per cent or more within a 12-month period. Hold implies expectation that total stock returns (including dividends) are likely to be in the -10 to 15 per cent range, while in the case of underperform rating the stock is expected to decline by 10 per cent or more over the next one year. For each brokerage with absolute return ratings, the percentage may vary and you need to check in the report.
Ram: Hmm…
Veena: Yes! If you go through numerous sell side reports, there will also be cases where the target price is way above current levels, but the analyst may have hold rating. It could be due to relative ranking methodology, or some brokerages might also factor stock volatility or certain risk elements into their ratings.
Ram: Ok, I understand it better now.
Veena: Understand what?
Ram: Read the fine print like we should in anything!
Veena: Read thoroughly before making your investing decision and don’t just go with the headlines.
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