Underperform Meaning Overview Examples

Making investment performance clearer: What is "Underperform"?

If an investment underperforms, it lags behind other securities. In a rising market, a stock underperforms if it doesn’t match or exceed gains in the S&P 500 Index. In a declining market, an underperforming stock falls faster than the broader market. Analysts assign the label "underperform" to a stock when it’s expected to slightly underperform the market’s return. This designation is also known as a "moderate sell" or "weak hold."

Key Takeaways

• An underperforming stock doesn’t match the broader market.
• An underperform rating varies depending on the brokerage firm issuing it; it can also be called a weak hold or moderate sell.
• An analyst assigns an underperform rating when a stock isn’t expected to keep pace with the market, but the concerns don’t justify a sell rating.
• A stock might receive an underperform rating for various reasons, often due to a comparison of company metrics with peers or the overall market.

Understanding Underperform Designation

Exact definitions vary among brokerages, but an "underperform" rating is generally worse than "neutral" but better than "sell" or "strong sell."

• Neutral is assigned to a stock expected to deliver results on par with the broader market.
• An underperforming stock is expected to slightly underperform, with greater losses in a down market and below-average gains in an up market.
• A sell rating is given to a stock expected to lose value.
• Strong sell reflects deep trouble for the company and the possibility of substantial losses in the stock.

A security might receive the underperform designation if it fails to meet or exceed a metric it’s being compared against. This comparison could be with the overall market, a competing company, or an index. Other issues that might result in an underperform rating include concerns about the company’s debt levels, price-to-earnings ratios, or loss of market share.

Examples of Underperform Rating

An industry, like utilities, might be described as underperforming due to economic growth boosting the industry, but inflation leading to higher interest rates, which negatively impacts the utility sector. Similarly, the real estate market might see low interest rates drive investment in Real Estate Investment Trusts, but rising rates can alter that dynamic. These factors can result in an industry not achieving its full potential and justify an underperform rating.

An analyst assigns an underperform rating to a specific stock if there are concerns that it won’t keep pace with others for various reasons, but those concerns don’t warrant a sell rating. For example, an automobile manufacturer might report a 12% total return for a fiscal year while the S&P 500 achieves a 23% total return for the same period, categorizing the auto manufacturer as underperforming.

Underperform outlook ratings can have varying meanings depending on the brokerage house. At Charles Schwab, an underperform outlook also implies a sell recommendation. If a company receives a "strongly underperform" outlook, it also gets a sell recommendation. These ratings indicate an expectation that stocks won’t meet benchmarks.