In a general sense, underperforming refers to performing poorly or unsatisfactorily in comparison to expectations or when evaluated against a certain standard. For example, one can perform poorly by failing an exam at school (or receiving a score below the class average), indicating an underperformance compared to the rest of the class).
In the workplace, where employees are often evaluated using customized assessments set by their employer, employees underperform when they’ve failed to meet certain standards or achieve certain goals or quotas set out beforehand. Companies themselves can also underperform in a similar manner.
In the financial world, underperformance occurs when stocks are doing worse in comparison to the overall market return. Underperforming is always evaluated against other similar stocks or securities in the stock market or against the return of the S&P 500.
If the overall market is rising, a stock underperforms by not experiencing gains in share price equal to or greater than the overall gain in the market.
When a market is generally performing poorly (a down market), a stock underperforms by falling faster than the rest of the stocks in the market and is deemed an “underperforming” stock.
What is Underperforming in Finance?
In the financial world, underperformance occurs when a stock’s valuation or return is doing worse in comparison to the overall market return or the expected return.
Underperforming is always evaluated against other stocks or securities in the stock market or against the return of the S&P 500. If the overall market is rising, a stock underperforms by not experiencing gains in share price equal to or greater than the overall gain in the market. When a market is generally performing poorly (a down market), a stock underperforms by falling faster than the rest of the stocks in the market and is deemed an “underperforming” stock.
For example, if a stock’s total return is 3% while the average total return in the overall stock market (or the S&P 500) is 5%, then the stock on a relative basis underperformed the index by 2%.
Determining What Underperforming Is?
Stock performance is regularly evaluated by analysts who might be employed by a brokerage house, private clients, or for investment publications that intend on making their findings public through reports. The analysts evaluate the financial conditions of a security using information available about the industry, and based on their analysis, a stock can be ranked or rated.
The term “underperform” is usually used to refer to a stock that is fundamentally stable, but is expected to perform below expectations when comparing it to the market or industry to which the security or stock belongs to. It should be noted that when a security receives an “underperform” designation, it does not mean that the stock needs to be sold; rather, it simply means that the stock is not expected to keep pace with the overall market or industry.
Other key terminologies for the underperformance designation include “moderate sell” or “weak hold.” The different terms roughly mean the same thing.
Designations Given by Analysts
It is important to understand the different types of ratings or designations that analysts will typically give after their analysis and research.
Neutral – Assigned to stocks the are expected to deliver results that are in line with the overall market; in other words, at the average
Underperform – Assigned to stocks that will likely perform below average
Sell – Assigned to stocks that are expected to lose value and as such, the analysts are recommending that investors who own such stocks sell them
Strong sell – Assigned to stocks where the company is in grave trouble and the stock could suffer substantial losses (for example, if there is a high risk of the company going bankrupt in the near future)
Reasons a Stock Could Underperform
There are several reasons where stocks could be expected to underperform in the market, according to analysts.
One reason is that growth is slowing down compared to previous quarters, with analysts thinking the downward trend might continue into the future. Another reason might be that a company with a higher debt load than its peers would be more adversely affected by a downward turn in the market.
It needs to be emphasized that the reason behind an underperformance designation is unique for each stock, and it is quite subjective depending on the company itself, the industry, and the current economic environment, among other factors.
CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: