There are many words and designations that analysts use to describe stocks and how they are performing.
One of these is “underperform” but what does it mean if a stock is underperforming? Is this something to worry about and should an underperforming stock be sold?
In this article, we will look at what it means when a stock underperforms and what you should do if one of your investments underperforms.
What Does Underperform Mean In Stocks?
If a stock is considered to be underperforming, it means it is not keeping pace with the overall stock market return.
For example, if the stock is listed in a rising market, it can be considered to be underperforming if it is not matching or exceeding the advances made by other stocks.
In a down market, it refers to a stock that is falling faster than the broader market. In short, an underperforming stock isn’t performing as well as the market.
You may also see underperforming stocks referred to as “moderate sell,” “weak-hold,” or “underweight” stocks.
The Underperform Designation
The label “underperform” can be given to stocks by market analysts after careful consideration of the stock’s performance and the wider market situation.
Analysts don’t always agree, however, so it is best to seek a consensus from several sources to truly judge the performance of a stock.
If a stock is considered to be underperforming, it is a warning to investors that the stock is likely to perform below par. Money invested in this stock is likely to see below-average returns in a rising market and greater losses in a down market.
“Underperform” is one of several designations that can be given to stocks to easily indicate how they are expected to perform. Although it is a sign of poor performance, it isn’t the worst designation a stock can receive.
Here are some of the other designations to look out for and they should give a better idea of how serious an “underperform” designation is.
- Buy – these are stocks that analysts recommend buying
- Outperform – this is a stock that is expected to perform slightly better than the broader market
- Neutral – this is a stock that is expected to match the performance of the broader market
- Underperform – this is a stock that is expected to perform slightly below the broader market
- Sell – this is a stock that is expected to lose value
- Strong sell – a “strong sell” stock will not only lose value but is a sign that the company is in significant financial trouble
You may see slightly different terms used from company to company. As you can see, however, although a stock that is considered to be underperforming is not going to be the most profitable stock on the market.
It is not a situation considered serious enough to warrant panic or sales. That’s why it’s often labeled as a “weak-hold” or “moderate sell” stock, also.
Why Do Stocks Underperform?
Underperforming stocks are not rare. In fact, the vast majority of stocks will underperform compared to the broader market. This is because of how the market and indexes are distributed.
The gains and returns of each market are largely produced by a very small number of stocks that perform at such a high level that they skew the overall return of the market.
Markets are also skewed towards overperforming instead of underperforming. A company worth $1 million can only lose a maximum of $1 million, but the amount of money it can gain is unlimited.
This means that there is a restriction on how far a market can fall, but no restriction on how high it can rise, leading to the possibility that a few well-performing stocks can drag the market returns to a higher level than most companies can achieve.
This is why the “underperform” designation is not seen as a sure sign that the stock needs to be sold. An underperforming stock can still turn a profit, it will just be at a lower rate than the best-performing stocks.
This is why many investors decide to invest in stock markets as a whole, instead of individual companies.
Should I Sell An Underperforming Stock?
Many factors decide whether you should sell any stock, and it is no different when it comes to underperforming stocks.
Whether you should sell depends on your own investment strategy and how you approach your financial goals, risk tolerance, and your time horizon.
If you are looking to invest in the stock market long-term, then you may prefer to ride out the dips and underperformance of your stocks instead of frequently buying and selling.
For short-term investors, however, it may be best to sell an underperforming stock and invest the money into one that is outperforming or recommended by analysts (see also ‘How To Become An Investment Analyst‘) as a strong buy.
Many investors like to adjust their stock portfolio, especially if the stocks are heavily concentrated in one sector. If this sector as a whole begins to underperform, then selling the stocks and diversifying into other sectors may be the best option.
Although it isn’t strictly necessary to sell underperforming stocks, you may find that doing so and reinvesting your money elsewhere will give you a higher return.
As always, before making any major investment decisions it is best to study the market or seek expert advice.
Final Thoughts
We learned that an underperforming stock is one that isn’t keeping pace with the broader market. In a rising market, it rises slower, and in a down market, it is falling more.
There are many reasons why a stock can underperform and underperformance isn’t necessarily a sign that the stock needs to be sold. Whether you choose to sell an underperforming stock depends on your personal investment strategy.
We hope that the information and tips in this article have helped to explain what it means when a stock underperforms. For more tailored and specific advice, you should consult with a financial advisor.
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