Stock Ratings Explained (Beginner's Guide)

Hello and welcome to a quick session about stock ratings. I've had a question in the community asking specifically about a new initiation rating from JP Morgan who have recommended an overweight position on Coinbase, who we know has recently IPO'd. So we'll circle back to that and use that as a bit of an example for our discussion, but to give you a bit of a top-level kind of oversight of where the research analysts sit within an organizational structure, if you think of an investment bank, you essentially have two parts: the public and private side of the bank. We're less concerned on the private side. This would include things more like corporate finance advisory services, the guys who really deal with things like capital raisings, M&A, so mergers and acquisition activity. What we're more concerned about is global markets, and within global markets you can kind of think of it as a kind of a sequence of different steps that happen when interacting with a client. And so in this case, the investment bank is a sell-side institution, the client being a buy-side participant. This could be a hedge fund, could be a wealthy investor, so on and so forth. Now, within the mechanics of facilitating a trade comes a trade idea. Now, this can come from things like economics. So it could be an economist talking in depth about the latest Federal Reserve monetary policy, and by default then they conclude that this is what they foresee happening with policy in the future, and this is the subsequent impact. And in a more short-term sense, you might have strategists then applying this as to short-term currency fluctuations or equity movement, for example, from the index perspective like the S&P 500. Then you have research analysts. So all of these guys are working with then facilitating origination of ideas to give to the salespeople and the sales traders who then inaction the trade. And that's how all these different parties are working with each other within that organization. Now the research analysts are kind of divided up into different subsections. So So you'd be kind of covering asset class typically. So fixed income, commodities, equities, FX, and so on. And within that you can break it down. And so if you just think of it like an onion and you peel the layers off, essentially it gets more and more granular as you go down. So when you start looking at equities, it's like, right, okay, what geographic area are we looking at? Okay, North America. But if you look at the S&P 500, there's a lot of different sectors covering different completely different areas and types of companies. So you might have consumer discretionary, technology, financials, so on and so forth. So then you would sit within, let's say, technology. But within technology, there are different types of tech companies. There are chip makers, there are suppliers of certain services that are more tech-oriented. There are lots of others. The point being then is that as a research analyst, you very much specifically are focused and concentrated on one specific area. Could even be one particular company in itself, depending on how much coverage that company requires. Now, how much coverage do these companies get? Well, it's somewhat dependent on the company. Obviously, the more— typically, the bigger the company, the more in fashion it is, the more trading activity participation there is in that stock in flow day to day and so on. then the more appetite there is to consume research, and so the investment bank team would generate more research reports. Now what happens at any one point in time is that any listed company generally that is tracked by these, these banks has a rating, and as we can see on this scale, there can be a different kind of going from 5 here in this case being a strong sell and being the most bearish to 1 being a buy and strong buy being the most bullish. Now, how do they derive these types of decisions? Well, there's a couple of different things that go on in an actual practice, which is studying and modeling of the company's financial balance sheet. That's probably integral, the most core to the process. The other thing then is talking to the management team of that particular firm and then also talking to their customers. Of that firm. And what you're trying to do as a sell-side research analyst in the equity space in this case is trying to determine, um, the most accurate forecast that you can of what that share price of that company will trade at some time horizon over the future. And from that you can then derive that the price of that share will either be higher, lower, substantially higher, or substantially lower, for example, or it might not even go anywhere. Which in this case you'd be a hold or otherwise referred to as neutral positioned. Now this could be useful for portfolio managers, for traders, because what we generally look for as market participants— say as a trader, I would look for things like a move from, say, a moderate buy to a strong buy. And what you can actually see on a day-to-day intraday basis is a stock price can react to what we call broker move, a broker recommendation. So in this case, a bank upping their kind of conviction buy rate over a certain company. And just because a major financial institution like Goldman Sachs might have done that, a lot of other people will then start increasing their exposure to that stock holding. And as such, then it's almost self-fulfilling. The stock price kind of goes up. Um, the other thing, and to go all the way back to the Coinbase example, now what Coinbase, uh, what's happened here is JP Morgan have come out and they've initiated Coinbase with a rating. Remember, Coinbase has only been trading for a couple of weeks. They've only just IPO'd. I'm filming this in, in May of 2021. So at this point, they have to kind of compute the numbers, if you like, and so they need to see a lot of information first before they can come out, and then they do what they call an initiation of a rating. And actually, what they've come out and said is that they, they have initiated them with an overweight rating. Now, this is quite important because there are some nuances around terminology of what different banks use. There's not actually a strict uniform approach that's benchmarked across all banks that they all use the same, so you do need to be aware of that. I guess the easiest way is what we've got here on Investopedia. If you think of it from a scale of sell to it's going to generally underperform the market, or the, the neutral price of hold to outperform to then buy. And so we're going up the scale of being the most bearish to the most bullish, left, left to right in this instance. And what they've come out and said is that they see it as overweight, and there's an end game. They see Coinbase shares rising from around 60% from the initiation of that report, of which, if you're aware of Coinbase, they've been selling off all the way into basically the last several weeks, particularly as crypto has come under some pressure with Elon Musk and, and so on and so forth, the kind of intraday flash crash we had in crypto on 19th of May. And so what they're basically saying, and I'm, I'm generalizing a lot, there's a lot more details to it, But if Coinbase, which— let me just quickly have a look— Coinbase IPO, they initially hit a high up at literally $430. They have traded on a low at the time of filming here on the 19th when we had that crypto crash on the intraday to $208. So if you actually look at that on a percentage basis, going from the high to low we've fallen in excess of 50%. So I think it's not that unusual to see, um, a firm come out and start to say at these types of levels the likelihood is that the price will move higher. And you could probably base that on assumptions that crypto trading activity is likely to increase. Coinbase is one of the mature platforms and it's likely to see greater revenues over time. And so with the price being depressed post an overvalued IPO, that generally speaking, over the long-term horizon, the share price will materially rise. And so therefore, I don't think the share price is going to do nothing. I wouldn't want to hold position. I foresee a better, more appropriate— there's a moderate buy or accumulate. I add to a position and it's going to outperform generally, but perhaps not just a conviction strong buy. The There are some other nuances in terminology. You do get some banks, I've seen some that have like a Super 10 list, strong conviction buy, which would be kind of ultra bullish above them, their most right extreme of this scale. And so again, it's more about the interchanges of these ratings. Now, when, when did they happen? They're not a set schedule. But, you know, one of the most meaningful times when a balance sheet sees the release of new information is quarterly earnings. So more often than not, you normally get a periodic review of ratings post the earnings release, because don't forget, they're not just reporting the previous quarter, they're reporting their latest outlook as well. And from that, then, you'll be able to derive some kind of forecasting model based on the internal metrics of which the company itself is looking at. And so you get a bit more accuracy and you can update then, is our stance as the bank appropriate in this stock or does it need reevaluating and reassuring of a new status essentially. And that is it. So hopefully that was useful, makes a bit more information. What I will do is I'll attach a PDF of this Investorpedia article if it helps to go into a few more practical examples to the video, you should better click on the paperclip on the side and it'll drop down a PDF from the top of the video. All right guys, I hope that was useful and I'll see you next time. Take care.