What it means
Research analysts at banks and brokerages publish price targets alongside a recommendation such as buy, hold or sell. The target tells readers how far the analyst thinks the share could move from today's price.
A target well above the current price supports a buy rating, and one below it supports a sell. The most common method is to forecast earnings per share for a future year and multiply by a price-earnings ratio that the analyst thinks is justified.
Others use discounted cash flow, which values the business on the cash it is expected to produce, or compare it with similar companies. Each method needs assumptions, and a small change in an assumption can move the target a long way.
Price targets matter to managers because they influence how the market thinks about the company. A string of target cuts after a poor quarter can pressure the share price and affect staff morale and bonus plans linked to share value.
They also feed into how investors judge whether a management team is meeting expectations. Targets should be read with caution.
Analysts have commercial relationships and may be slow to downgrade, and the target is only as good as the forecast beneath it. Looking at the range of targets across several analysts, and the reasoning behind them, tells you more than a single number does.
A target also has a time frame and a risk attached. A twelve-month target of $72 is not a price that will be reached on a given date, and many things can push a share off course, including a change in interest rates or an unexpected loss of a large customer.
Managers should also remember that targets tend to cluster after big news and are revised in steps. A company that reports a strong quarter often sees several targets raised within days, and the average of those targets is a better gauge of sentiment than any single note.
Treat the movement in the average as a signal about how expectations are shifting.
In practice
Real-world examples.
Example
A broker publishes a $72 target on a retailer trading at $60 and rates it a buy. The investment committee at a pension fund reads the note, checks the earnings forecast behind it and decides whether to add to its holding.
Example
A software company misses its revenue guidance, and three analysts cut their targets within a week. The chief financial officer prepares for investor calls by working out which forecast assumptions the analysts have changed.
Example
A start-up founder with share options reviews the targets set by analysts covering a listed competitor. The spread between the highest and lowest targets shows how uncertain the market is about growth in the sector.
Formula
Calculation
Target price = Forecast earnings per share x Target price-earnings ratio, and Implied upside = (Target price - Current price) / Current price.
An analyst forecasts that a retailer will earn $4.00 per share in twelve months, and judges that the market will pay 18 times earnings. The target price is $4.00 x 18 = $72.00. The shares currently trade at $60.00.
The implied upside is ($72.00 - $60.00) / $60.00 = $12.00 / $60.00 = 20%. If the analyst cuts the forecast to $3.50 per share while keeping the 18 times multiple, the target falls to $3.50 x 18 = $63.00, and the implied upside shrinks to $3.00 / $60.00 = 5%.Case study
Seen in the real world.
Greenfield Appliances is a fictional manufacturer of kitchen equipment. In an illustrative quarter, the company reported earnings slightly below forecasts, and five of the eight analysts covering it lowered their price targets by between 8% and 15%.
The finance director reviewed the notes and found that most of the cuts came from a lower earnings forecast, not from a change in the multiple. That told her that the market's concern was about next year's sales, so she prepared a clearer explanation of the order book for the next call.
In this fictional case, the targets recovered two quarters later, once orders improved. The useful part was reading the logic behind the numbers rather than reacting to the headline cuts.
Watch out
Common mistakes.
- Treating a price target as a guaranteed outcome, when it is a forecast with a margin of error.
- Reading the target without checking the earnings assumption and multiple behind it.
- Relying on one analyst, when the spread across several analysts is more informative.
Questions
People also ask.
How long is the time frame for a price target?
Most are set for twelve months ahead, but the report should state the period.
Are price targets independent?
Not always, because analysts may work for firms that have business relationships with the company, so read them alongside other sources.
Does the company set its own price target?
No, the company does not publish one for itself, because targets come from outside analysts and investors.
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