What Does it Mean For a Stock to be Overweight?

If you are just beginning to invest in the stock market, there's a lot you need to know. You might want to know the best apps for first time investors. You might want to know what is an ETF, or what the best mutual funds for your budget are. On practical levels, there's a lot to learn.

Then, there's the lingo.

There are so many different things you might hear when discussing stocks. You might overhear people talking about "shorting the market," or hear about Japanese candlestick charts. Perhaps one of the most puzzling terms for newbies is the term "overweight."

Obviously, you can't plunk a stock on a scale and ask it to take a diet pill. So, what does it mean for a stock to be overweight? We decided to take a look at the facts to find out.

With almost any kind of investing system, stocks are given a rating.

Stocks can be rated in a variety of different ways. They can be rated by volatility, by price, or even by the amount of people who are buying them. When people discuss the possibility of a stock to be overweight, they're actually talking about a term used with three-tiered rating systems.

Confused? Well, the other two ratings in these systems are "underweight" and "equal weight." When these kinds of ratings are used, they are talking about how a stock measures up according to a benchmark.

Translation: for a stock to be overweight, it will have to have too much "stuff" in at least one benchmark.

The thing is that it's hard to tell what the "extra" is, unless you know what the benchmark that analysts are discussing is. In most cases, the term "overweight" tends to apply to ETFs and other funds that are composed of a bunch of different securities.

Generally speaking, it's about the composition of the stock compared to the market index or model it's based on. It's hard to understand without an example, so let's try one out.

To understand what it means for a stock to be overweight, we're going to take a look at an example of a theoretical ETF.

Let's pretend that we have an ETF that's based on the S&P 500 market index. Let's also say that the S&P 500 has a stock that makes up around 3 percent of the entire index. The ETF would be overweight if it contained more than 3 percent of that stock in its portfolio.

On the other hand, it might be underweight if the ETF had only 2 percent of the stock in its portfolio. It would be equal weight it it had 3 percent. It makes sense, doesn't it?

You can also have a portfolio that is called overweight.

Now that you know what it means for a stock to be overweight, let's take a look at another way this term is used. Let's say that you have an investment portfolio.

Right now, this portfolio is made out of 25 percent stocks and 75 percent bonds. Your financial advisor showed you the "ideal benchmark" portfolio ratio, and it was actually 25 percent stocks, 5 percent real estate, and 70 percent bonds. In this case, your portfolio's number of bonds would be overweight because it's more than the benchmark.

It's worth pointing out that there's nothing wrong with an investment being overweight or underweight.

A lot of finance managers will actually prefer a stock to be overweight in a portfolio if they believe the stock will outperform the typical market. After all, if you have a high-performing stock that makes up a bigger percentage of your fund, you'll have better returns.

Similarly, managers might also choose to have a stock be underweight compared to the benchmark if they're worried about it failing. This would help reduce losses.

That being said, you should understand the reasoning behind why a group would suggest a stock to be overweight.

Knowing what the benchmark they're using is, and also knowing why the stock is overweight is crucial if you want to make sure you can maximize returns. The "why's" are just as important as the "how's" here.

If a stock is overweight for no good reason, it's not a good look. On the other hand, if a stock is overweight because it recently surged in price, there may be reason for it to be that hefty.

Overall, it's a term that's meant to help determine the attractiveness of a stock.

If you look on sites like the Motley Fool, they'll tell you that it might be a good thing for a stock to be overweight in a lot of securities. In many cases, it could be a bargain buy that could beat the market. That's why a lot of people prefer overweight stocks.

Vagueness, though, makes this term very shifty.

There's a lot of different ways for a stock to be overweight. The term itself is notoriously vague due to the different meanings it can take in context. If you're not sure what the weights in a portfolio are supposed to be, it's best to ask a financial advisor what to do.

Overweight ratings don't hold as much water as others, simply because it's not easy to determine what an analyst means by it.

Much like with other words in the investing world, context is everything. Sometimes it's good to have an overweight stock, other times, it's not. Getting a good course in how to invest in the stock market can help you discern whether or not a fund is a good purchase.

It's not a bad thing to reach out for more help, you know. This Udemy course, Stock Trading with Technical Analysis, will teach you all about the ins and outs of dealing with an overweight, underweight, or equal weight stock.