If you are invested in individual stocks, then you understand that there are a number of factors that can move a stock. Perhaps one of the biggest market movers, in an individual stock, is quarterly earnings. However, the biggest stock moves can come from analyst upgrades and analyst downgrades. While analyst upgrades are rather common, analyst downgrades can create a bigger movement in an individual stock. Therefore, it is important to understand what analyst downgrades are and how they work.

What is an Analyst Downgrade?

An analyst downgrade is a public announcement, by an analyst, that a stock’s price is higher than it should be. The analyst will usually cite any number of reasons for the downgrade.

  • Overpriced stock
  • Weak performance
  • Increased competition
  • Unfavorable market conditions

The analyst will usually place a 12-month price target on the stock. From there, the stock may make an immediate downward movement, in price, based on the reputation of the analyst.

How to Find Analyst Downgrades?

There are a number of ways to find the latest analyst downgrades. Most financial news websites will have a page dedicated to recent upgrades and downgrades. Also, if you watch CNBC, Fox Business, or Bloomberg, analyst downgrades will usually be announced if the stock being downgrade is widely held.

How Effective are the Analyst Downgrades?

There are usually three factors that will affect the how far a stock will fall when it is downgraded.

  • The reputation of the analyst – If the analyst in question is known as a top authority in the sector, the downgrade can have a great negative impact on the stock. However, a downgrade from a little-known analyst may have little to no effect.
  • The number of analysts who are making the downgrade – Occasionally, a number of analysts will downgrade the same stock at around the same time. This could happen if the company is announcing bad news or if the price action, of the stock, has moved very quickly to the upside. Multiple downgrades can have a big negative impact on the stock.
  • The current conditions of the market – During a bull market, downgrades may not have much of an impact on a stock. During bear markets, downgrades could have a major effect on the stock.

Types of Analyst Downgrades

There are a number of different types of analyst downgrades. The thee more common types of downgrades are the following:

  • Individual Stock Downgrade – This is the most common downgrade where an analyst gives a negative forecast of an individual stock.
  • Sector Downgrade – This is a downgrade of a group of stocks in a given sector. This is less common and will have less of an impact of the individual stocks in the sector. An example of a sector downgrade was a recent downgrade of Bank of America and Goldman Sachs by Atlantic and 1MDB.
  • Overall Market Downgrade – This is a downgrade of the overall market. These downgrades will have little impact on individual stocks.

How Should Investors React to Analyst Downgrades?

Just about every stock will be downgraded once in its lifetime. And investors who are planning to hold a stock for the long term should ignore downgrades. However, there are some day traders who may want to use downgrades to their advantage. When a stock begins to fall, it can be hard for that stock to find a bottom. Many day traders will short the stock in hopes of a quick profit. This is a risky strategy that should only be attempted by the most experienced day traders.

A Contrarian Opinion on Analyst Downgrades

While many investors believe that analyst downgrades can have a big negative impact on a stock’s price, there are some who believe that analyst downgrades don’t really matter. In a recent article on Forbes, Marc Gerstein of Intelligent Investing believes that downgrades are less relevant because Wall Street firms don’t invest much on the sell side of their analyst division. Because of that, downgrade reports are simply not as compelling. And Mr. Gerstein believes that analyst downgrades are taken less seriously than analysts upgrades.