When investors evaluate returns, they often place less focus on absolute results than on how those results compare with the "other guy." A 20 percent return might seem great unless you discover that every investment in a comparable sector or company exceeded 30 percent during the horizon that you are evaluating. Wall Street analysts also use the terms underperform or outperform when discussing their outlooks on individual stocks.
Markets Move Up and Down
The investment markets, both stocks and bonds, move up and down as a group. When the stock indexes are down, a majority of stocks are trading at lower prices. When indexes are going up, this represents that most stocks will be up to one extent or another. The terms outperform and underperform are used to discuss the return from a specific stock, bond or mutual fund compared with the average of the group or an index. For example, stock mutual funds are often analyzed in relation to whether a specific fund outperformed or underperformed the S&P 500 stock index.
Wall Street Stock Forecasts
Analysts who cover individual stocks can use the terms outperform and underperform to indicate how they think a particular stock will do in relation to other stocks in the same industry. An analyst uses these terms to indicate his opinion on the investment potential of a particular stock. An outperform rating might be viewed as another way to say buy the stock. An underperform from an analyst can be viewed as a sell recommendation. This can be an important indication because analysts rarely give an actual sell rating, but you can read between the lines if a stock is downgraded to underperform.
Results Relative to Benchmark
The performance results of mutual funds are often compared with benchmark indicators such as a stock or bond index. Fund investors like to know whether their actively managed funds have outperformed or underperformed the overall stock market or even index mutual funds. If you cannot determine whether a fund has a good chance of outperforming the selected index, you are better off buying an index fund designed to match the performance of the index. If you can find a fund manager who consistently beats the indexes, you have an outperforming winner.
Your Personal Investment Results
Comparing your personal returns with a benchmark can be useful, but there might be reasons for variations in your results relative to the benchmark. If you lean toward conservative investments, you will underperform when markets are going up and outperform when prices are dropping. If you have an aggressive approach to selecting investments, your results should show the opposite performance in up and down markets.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.