What it means
Equity analysts at banks and research firms publish ratings such as sell, hold and buy. When an analyst changes a rating from hold to buy, the move is called an upgrade, and it usually comes with a higher target price.
The change signals that the analyst now sees more room for the shares to rise. Credit rating agencies work differently.
They grade borrowers and bonds on scales that run from highest quality to highest risk, and an upgrade means the grade has moved up. A higher grade tells lenders that default is less likely, so the borrower can usually raise money at a lower interest rate.
Markets often react quickly. A stock upgrade can lift the share price on the day, especially if it comes from a well-followed analyst or surprises the market.
The effect is usually strongest when the analyst gives new information or a fresh view, and weaker when the change simply follows a price move that has already happened. For a business, a credit upgrade can reduce borrowing costs, widen the range of lenders and make it easier to win contracts from cautious customers.
Some funds can only hold bonds above a certain grade, so a move into that range opens a new set of buyers. Finance directors therefore work closely with agencies and explain progress on debt, cash flow and strategy.
The word has an everyday meaning too, such as upgrading equipment or software, and in that case the cost is either an expense or an addition to the asset on the balance sheet. The accounting question is whether the work extends the useful life or capacity of the asset, in which case it is usually capitalised.
Upgrades should be read with care. Analysts can be wrong, they may have business links with the company, and a rating is an opinion and not a guarantee.
Investors should ask what has changed in the underlying numbers.
In practice
Real-world examples.
Example
A broker upgrades a retail chain from hold to buy after its inventory levels improve. The analyst raises the target price by $8 and says earnings should recover. The shares rise 4% on the day, though the analyst warns that the target depends on the company keeping its margins.
Example
A rating agency raises a utility company's bond rating by one step because debt has fallen and profits are steadier. The company refinances $200,000,000 of bonds at a lower interest rate a month later. The finance director reports the saving to the board.
Example
A manufacturing firm upgrades its production line, spending $750,000 on machines that double output and extend the line's life by eight years. The accountant treats the spending as an addition to the asset because it extends capacity and life. It is then depreciated over the new useful life.
Formula
Calculation
Upside to target % = (target price - current price) / current price x 100
Suppose an analyst upgrades a stock from hold to buy and sets a target price of $66. The shares currently trade at $55. Upside to target = (66 - 55) / 55 = 11 / 55 = 0.20, or 20%. For a credit upgrade, if a company with $100,000,000 of debt pays 0.5% less in interest after the upgrade, it saves 100,000,000 x 0.005 = $500,000 a year.Case study
Seen in the real world.
Cedar Logistics is an illustrative, fictional freight company with $80,000,000 of bonds that pay interest at a rate linked to its credit rating. After three years of reducing debt, it applied to the agency for a review.
The agency raised its rating by one notch. Under the bond terms, the interest rate fell by 0.5 percentage points, saving 80,000,000 x 0.005 = $400,000 a year.
The finance director used the saving to fund new trucks, and she reported the change to the board with the new rating letter attached. The illustrative lesson is that a credit upgrade is the reward for disciplined financial management, and it feeds directly into profit through lower interest costs.
Watch out
Common mistakes.
- Treating an upgrade as a guarantee that the price will rise, when it is only an opinion and the market may already have priced it in.
- Ignoring who issued the upgrade, when the analyst's record and independence affect how much weight it deserves.
- Confusing a credit upgrade with an equity upgrade, when they measure different things: repayment ability versus expected share performance.
Questions
People also ask.
Why do share prices move on an upgrade?
Investors treat it as new information that the future looks better than previously thought, and some funds buy on rating changes.
What is the opposite of an upgrade?
A downgrade, where the analyst or rating agency lowers its view.
Does an upgrade change what a company owes?
Not directly, but a credit upgrade can lower the interest rate paid on new borrowing and sometimes on existing debt with rating-linked terms, so the benefit appears gradually in the finance cost line.
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