Investors may have heard a portfolio of investments being described as overweight. And in a different—though related sense—stock analysts may make recommendations by saying a stock is overweight. Clearly this term doesn’t have anything to do with physical mass, so what do financial professionals mean when they use it to describe investing in stock as related to an individual’s portfolio and investment strategy?
What is an Overweight Portfolio?
Overweight can refer to a portfolio that holds more of a stock or other investments than it theoretically should. For individual investors, this might mean that more of a portfolio is allocated to stock than the investor planned for.
For example, say an investor has a portfolio allocation in which 70% of its values is held in stock and 30% is held in bonds. If the stock market goes up, the proportion of the portfolio held in stock may grow beyond the 70% mark. At the point, the portfolio may be described as overweight in stocks, and an investor may want to rebalance to bring it in line with their initial allocation plan.
It may come as no surprise that the opposite of an overweight allocation is an underweight allocation. For example, if the stock allocation in the portfolio above fell below 70%, that allocation could be described as underweight to stocks.
The term can also apply in a narrower sense. For example, a stock portfolio could hold too much stock in one company, sector, or geographical region. In each case the holding could be described as overweight.
Professional fund managers may also use overweight to describe portfolios they work with that are off track with their index, including mutual funds, exchange-traded funds, and index funds. From time to time, a fund may get out of line with its benchmark index by holding more or less of an investment that index tracks.
For example, say an index fund is built to track the S&P 500. To track the index, fund managers will usually attempt to hold every stock in the index. Additionally, they will try to match the proportion of each individual company their fund holds to the index as well. So if stock A represents 5% of the original index, the fund will also hold 5% of stock A.
Some funds have a little bit of wiggle room in terms of how far they can stray from the index. Some might be allowed to hold more or less stocks if they think the stocks will outperform or underperform. When they hold more than the index, the managers are taking an overweight position. And when they hold less than the index, the managers are taking an underweight position.
What Does Overweight Mean to an Analyst?
Stock analysts research investments and make recommendations based on their findings. They are typically employed by large banks or investment firms, where they pore over company filings and reports, talk to management, and compare companies with competitors to understand whether a company is healthy and positioned for growth or if it’s unhealthy and in for a slowdown. One of the ways an analyst shares these findings with investors is through recommendations.
When a financial analyst describes a stock as overweight, they believe it is positioned to outperform other stocks or the broader market over the next six to 12 months. Conversely, if they describe a stock as underweight, they believe that it will perform poorly in the future.
In this case, the terms overweight and underweight are more or less synonymous with “buy” and “sell.” So why don’t analysts use these simpler-to-understand terms? The answer is many of them feel uncomfortable making explicit recommendations. In other words, they don’t want to tell investors what to do. Rather, they prefer to offer their perspective, leaving investors to make investment decisions themselves.
That said, overweight and underweight do have a slightly different connotation than buy and sell. Rather than a simple order to acquire stock or sell them, the terms suggest a recommendation that a portfolio hold more or less of a particular position than an index or other benchmarks would suggest. It may mean acquiring more, or selling some, of a particular investment. But it wouldn’t necessarily mean buying something new or selling all of a position.
In many cases an overweight or underweight recommendation might not be very useful for investors. For example, if an analyst recommends an overweight to a certain commodity but an investor’s portfolio doesn’t hold any commodities, this information may not have much bearing on their situation.
Where Does This Weighting System Come From?
To understand weighting systems, it’s important to understand that market indexes assign a weight to the investments they track to be sure that they accurately reflect overall performance. For example, the S&P 500 tracks 500 large-cap US companies. The index is weighted by market capitalization, which is the total value of all the stocks that a company has issued. Market cap is calculated by multiplying the number of shares by current share price. Companies are weighted based on the proportion of the overall index their market cap represents.
Other indexes may use a different weighting system. The Dow Jones Industrial Average , for example, tracks 30 blue chip companies and weights them based on stock price. Companies with a higher share price are given more weight than those with lower prices.
Because of these different weighting systems, it’s important to understand that an overweight to a particular stock with regards to one index may not be the same when it comes to another. In fact, it may be underweight, or equal weight.
How Can Investors Interpret Overweight?
Investors looking at stock analysts’ overweight recommendations may want to carefully consider whether those recommendations fit with their financial plan. For example, is the overweight recommendation based on the investor’s same time horizon? If an analyst’s recommendation is based on the next six to 12 months, it may not make sense for an investor with a longer time horizon to follow it. Also, does the recommendation fit in with the investor’s goals. An investor who avoids petroleum stocks might not follow an overweight recommendation for oil companies.
Also, it’s important to realize that an overweight recommendation is, in essence, a recommendation away from diversification, which can be one way to help protect a portfolio from market risk. An investor who prioritizes diversification in their portfolio may not want to overweight a particular asset.
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