Do You Adjust Your Price Targets?

I hate static price targets!  Hate them!

Most of the research we read or see on TV is a bureaucratized and sanitized version of analysis.  The firm determines something, and that is the official version for public consumption.  Those who pay no attention to changing conditions add no value for investors.

Did you notice that things are better in Europe?  That economic data have improved?

If not, perhaps you have the wrong approach to your research.  You need to be flexible, responding to new information.  Most of those who claim success at market timing are exaggerating.  If you missed this prior article that showed how to check track records, please take a look.

Examples:

A big-time firm sets a price target for a stock.  The stock rallies and hits the target.  Then they move the target up by 20%.  How helpful is that?

Suppose it goes the other way.  The stock sells off and the firm lowers the target while retaining a "buy" rating.  How helpful is that?

This is why I do not follow analyst price targets for stocks.  I review their research and I draw my own conclusions.  I revise my price targets each week.  I review my most recent expectations for corporate earnings and cash flow and compare this to the current price, the market multiple for similar stocks, the multiple for the overall market, and the return from alternative investments.

Isn't that what you would do if you took the time?

I described the flawed process of big firms in this article from 2010.  By contrast, I described my own approach for our Great Stocks program:

"Analyst reports can be very helpful.  There is a lot of information about the business model, recent trends, and risk factors.  Reading several reports can help in identifying the consensus, especially what the analyst community is worried about.  Knowing these concerns can help you anticipate upgrades and downgrades.

I use the raw data to set my own target prices, and I review the targets frequently.  I select stocks with a target that is at least 25% higher and with attention to near-term catalysts and risks.  I have found that this is a good level for a goal, understanding that it will be achieved only some of the time.  Trying for home runs is tempting, but not as effective.

I almost never own a stock at the time it hits a target.  This may seem strange, but consider two cases:

1. If the stock makes a big move, but the fundamentals have not changed, it no longer has the potential for an additional 25% gain over the next twelve months.  I sell and move on to something that meets my criteria.  I sell these stocks before the target is reached.
2. If the stock makes a big move and the fundamentals keep pace, the target is moving as rapidly as the stock price.  This enables me to hold stocks like Apple."

Current Investment Implications

As the first quarter of 2012 draws to a close, there is a fierce competition to call the market top.  I watch the entire spectrum of opinion closely.  At the risk of oversimplifying, I will suggest two broad viewpoints:

Those with a static market target.  These observers started the year with an idea and they will not be budged!  Members of this group share some or all of the following characteristics:

• Using prices from ten years ago to determine current market values;
• Excessive fixation on calendar effects;
• Excessive attention to the length of past market cycles;
• Substituting fake data (what they personally believe interest rates SHOULD be, what they think profit margins SHOULD be, using the discredited Shadow Stats, complaining about seasonal adjustments, and making other assorted excuses);
• Over-emphasis on debt and austerity;  and most importantly....
• Embracing a political viewpoint that excuses all other analytical mistakes.

Those who remain flexible.  These observers are watchful and wary, but open to new data.  Members of this group share some or all of the following characteristics:

• Monitoring earnings expectations as the best guide for future stock prices;
• Using long-term data as the basis for establishing earnings growth and profit margins;
• Understanding that there is no set time for a market cycle.  A deep recession may take a longer recovery period.  We might only be in the third inning of the recovery.
• Accepting the reality of new data.  No Excuses!  No changing of methods.  No rejection of seasonal adjustments after always using them in the past.  Not starting with a pre-conception and ignoring contrary evidence;
• Recognizing progress.  If a few months ago you thought that there was systemic risk from Europe and there would be a deep recession there, did you modify  your market viewpoint when this did not happen?  The successful investor constantly adjusts for risk, using indicators like the St. Louis Financial Stress Index;
• Ignoring politics.  This is true whichever party is in power.  It is part of the electoral process for the "outs" to disparage any signs of progress.  If you want to succeed as an investor, you learn to ignore this background noise.

Conclusion and Current Ideas

The two profiles provide a sharp contrast.  Which fits your own approach?

There are many stocks that are attractive despite higher prices?  Why?  The earnings potential has grown faster than the price, and the risk is lower.

Some stocks that I see in this group are Oracle (ORCL), Apple (AAPL), JP Morgan Chase (JPM) and Caterpillar (CAT).  These are a few illustrations, but there are many other tech stocks, deep cyclicals, financials, and health care names that are worth consideration.

 

Comments

[Chris Tinker]

I think that you will find that price targets are rarely worth the paper they are written on - they are not really designed to reflect a rational risk/reward trade off as they are done at a single stock - or at most a sector level and the time frames are rarely explicit. Essentially they represent a guess of where a DCF model might suggest "value" lies and typically feature a presumption about a "normal" valuation multiple. This approach is typically not systematic or "learnt" in the sense that a failure to reach a target rarely prompts a variation in the forecast approach. Bottom line is that Analysts are not rewarded for their target prices so they receive relatively little focus.

[Lasse Rochstad-Lim]

Hi Jeff,

I note that there was a reference to your article above by Mr Mick Weinstein at Trading Deck in Marketwatch. However, i have noticed that MW now very often use very "catchy headlines" which does disservice to the articles content. The article has the heading "Analysts Price Targets are for Losers". That did grab my attention. However that is not exactly what your article says...

Anyway .......

I have advocated in MW and CBNC that someone ought to start a proper ranking of analysts accuracy. I don't think there is one. Please correct me if I am wrong.

If someone could build a record over say 5 to 10 years showing how accurate their BUY/SELL/HOLD recommendations and their price target is, it would be meaningfull.

My experience, like yours and many other investors is that Analyst's price targets are often not very relevant nor accurate.

Tudor Investment Holdings Pte Ltd
Singapore

[Chris Tinker]

Hi Jeff,
I agree entirely with your thoughts on this. My market timing and valuation approach does exactly that - it re estimates on the basis of new information on Earnings, cash flow, sales, book value and Ebitda. It enables me to put together a rolling 1 month, 2 month and 12 month target price which changes daily dependent upon information shifts INCLUDING changes in the price. Risk is then a function of how far the price is from value and the outlook (trend) of that value. I've been running this approach for 8 year now and really struggle with comprehending how any static price target approach can possibly work.