What is Underperform?
"Underperform" is an analyst recommendation given when a stock is expected to do slightly worse than the market return. The designation is also known as market "moderate sell" or "weak hold."
Understanding the Underperform Designation
A security might receive the “underperform” designation if it does not meet or exceed a metric it compared against. This can include the overall market, a competing company, an index, or some other measure. For instance, though a company sees growth or positive earnings for a quarter or for the year, those returns might not be on a par with the market. So if an automobile manufacturer reports a total return of 12% for its fiscal year while the S&P 500 sees a 23% total return for that year, the auto manufacturer could be classified as "underperform."
The rating indicates that although a company might be turning in positive results, it could be performing better in the current market.
Why a Company May Receive an 'Underperform' Rating
A variety of issues could bring about such results. The company might be carrying debt that puts pressure on its returns.
An industry might be described as underperforming. The utilities industry might receive this designation because the growth of economy may boost the industry yet inflation could result in higher interest rates. The real estate market might have seen low interest rates drive investment in REITs, but rising rates can change that dynamic. Rental rates could be strong, yet if more inventory is about to become available, it could shift the market. Those factors could create a circumstance where an industry is not generating returns to the full potential.
Depending on the brokerage house, an outlook rating of "underperform" can have different degrees of meaning. At Charles Schwab, for instance, an outlook of "underperform: also carries a "sell" guidance. If a company receives a "strongly underperform" outlook from the firm, it will also receive the "sell" guidance. These ratings can mean there is an expectation that the stocks will not meet benchmarks. Furthermore, if the security continues to underperform over extended periods, the holder of that stock may need to consider whether or not they should hold or sell it.
While there may be potential for a company to take action that improves its prospects and increase the value of its stock, the longer it underperforms can lead to declines that weaken the portfolio.