Ask a Fool: What Does It Mean When a Stock Is Downgraded?

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Q: One of my stocks fell 5% the other day, and when I tried to find out why, all I learned is that an analyst had downgraded the stock. What does this mean, and should I be worried?

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Analyst opinions can certainly move stocks -- sometimes by a lot. For example, an analyst recently downgraded Square, and the stock plunged by 16% as a result.

However, my advice is to take an analyst downgrade with a grain of salt. It's important to keep in mind that a downgrade is simply a change in a particular analyst's opinion about a stock. For example, the Square downgrade was because an analyst felt that the company's experimentation with bitcoin won't have the positive effect the stock market seems to be expecting. In addition, the financial institution that employs the analyst generally releases the report to its own clients, and many may choose to sell, creating downward pressure on the stock.

In fact, analyst downgrades can create buying opportunities in solid companies on which you've done your own research and feel that there is strong long-term potential.

However, a flurry of downgrades on the same stock in a short period of time, or a downgrade that fundamentally challenges your investment thesis can be a sign of trouble. For example, if several analysts downgrade a stock and all of them say that there's a strong possibility of a dividend cut, this could be a good reason to take a closer look at the stock -- especially if the dividend is one of your main reasons for owning it.

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Matthew Frankel owns shares of SQ. The Motley Fool owns shares of SQ. The Motley Fool has a disclosure policy.