If you do a Google search for 12-month price targets, you get something similar to this:
“* Apple Inc (NASDAQ:AAPL)
The 39 analysts offering 12-month price forecasts for Apple Inc have a median target of 175.00, with a high estimate of 200.00 and a low estimate of 118.00. The median estimate represents a +32.23% increase from the last price of 132.35.*
I’m not so naïve to think that I can ‘expect’ a 32% return in a year on Apple stock that I buy today, but that’s what appears to be the consensus of a group of analysts. So:
What does this ‘price target’ mean in practical terms for an investor?
Are the 39 analysts likely to be using similar methods to produce their targets?
Does the wide spread mean that each analyst gave a single number, and so the 39 answers fit on a bell curve, or are they all providing a range, with varying degrees of confidence?
Is there a site/app that can display how close the previous 12m predictions came to actual performance today? Seems to me that if any analyst can consistently predict close to actual performance with a narrow range, they would be rich and famous pretty quickly for beating the market. Assuming that doesn’t happen, why pay any attention to stock analysts?
In practical terms, price targets provide a consensus of how the analysts feel about a stock’s future at any given time. This is usually distilled into a Buy/Sell/Hold recommendation (currently they’ve got 32/38 Buy recs, 6 Hold. The last time AAPL fell short on an earnings estimate was April 2016.
Not many people care about the individual analysts (JP Morgan, B of A, Chase, etc) though you could likely find their track records on their own sites. The average is a safe enough bet for most people. I don’t care when one headline-seeker downgrades their estimate (the current low estimate is $122, the high $212); I worry when a bunch do.
Would wealthy investment bankers and hedge fund managers not qualify?
There are a couple of different ways analysts predict the movement of a stock. They might compare the stock against other stocks in the same industry. Or they might used more complex valuation methods (Discounted Cash Flows for example) to asses whether a stock is under or over valued.
Day traders often do a sort of analysis where they look for patterns in a stock’s price chart. I don’t know how effective this actually is.
A simple guideline is that stocks expected to appreciate more than other stocks have some slight tendency to slightly outperform relative to stocks expected to underperform but those effects tend to be swamped by changes in the level of value of the underlying stocks. That is, you could try picking only stocks that are predicted to outperform in the future but the general stock market movement will have a greater effect on your portfolio performance. Furthermore, the transaction and tax costs of trying to implement this strategy are expected to be greater than the potential gains from following it. Finally, the additional risk you are taking will be uncompensated so you are getting greater volatility without expecting higher returns. What does it mean for the average investor? Ignore the analysts. Diversify your asset classes consistent with your risk tolerance and goals, buy index funds, rebalance periodically, and reduce your market risk as you approach the time when you will need the money.
Generally, they will use similar methods but they will have somewhat different assumptions about the future so they will come to different conclusions. For example, to value Netflix, each analyst will consider subscriber growth, subscription prices, programming costs, labor costs, and revenue from advertising. But they will all have different guesses about those numbers. How many subscribers will Netflix gain or lose? Will Netflix raise its prices? By how much and how will that affect subscriber growth? Will they increase programming costs to get more marquee shows and movies or cut programming costs to decrease expenses and increase margins? How will that affect subscriber growth? Will they cut staff to reduce expenses? Will that make the site less reliable, make it harder for them to attract and retain production talent, decrease the ad sales of their new ad-based product? How will those changes affect subscriber growth?
And Netflix historically has been just about the easiest business to value because they really only have a single product. Find a complicated business with lots of business lines and try to model its earnings growth. At the end, what you have are a range of informed guesses that individually aren’t worth that much but tend to cluster around reality. Unless the stock market just moves against them.
Different analysts/investment banks have different styles. Some will give a target price. Some will give a range of target prices. The services that aggregate those estimates have consistent ways to deal with that. I suspect they just take the midpoint of the range and factor it into the average.
I’m not aware of anyone that does this systematically though I have read studies where researchers look at performance over some period of time. On the whole, the analysts don’t outperform the market. Doing it on a rolling basis would be tough, in part, because different people release their reports on different days and with different time horizons. One analyst might say in March 2022 that Apple has a $160 price target in the next twelve months while another analyst said in May 2022 that Apple has a $150 price target by the end of the year, while another said November 2021 that Apple will be between $140 and $155 by November 2022. Who was righter if Apple is at $145 on November 1, $160 by December 15, and $152 by March 2023?
Your cynicism is well warranted. There is no indication that any person can reliably beat the market with any degree of statistical confidence. If they beat the market last year, it might have been a fluke. With thousands of analysts in the market, some will have two, three, four, etc. fluke years in a row. By the time you have observed their performance long enough to be reasonably confident that their performance wasn’t a fluke, you have missed most of the period of outperformance and the money manager is close to retirement or death.
The actual targets themselves are largely a fluff number meant for public entertainment and not thought of seriously by investors. What’s more important was the process used to arrive at the numbers. What factors were considered, how are they integrated? What’s changed since the last analysis? What assumptions underlie the analysis and what degree of certainty is behind each one etc. Investors can take a bunch of diverse viewpoints and input their own assumptions and thinking to produce an investment thesis on whether the stock is over or undervalued.
Thanks for a comprehensive answer. The point about ‘transaction costs and general market movements’ - if I’m understanding your point correctly, you are saying that a strategy of picking the one stock the average analyst thinks will rise by 30% is statistically less likely to succeed than being diversified in the general market?
The point about ‘fluff’ (made by Shalmanese) is also very interesting. I hadn’t considered that. Presumably though, too much analyst hype about stocks would eventually cause investors to factor that in. I suppose I’m looking for that, really. Perhaps along the lines of: “If you say Apple will rise by 30%, but the tech sector generally only by 10% and the whole economy by 2%, then perhaps 8% max is still realistic.”
So hypothetically, if someone was careful to diversify across sectors and countries and selected only stocks that analysts agreed were a ‘buy’, they’d be still sensible to expect no better than the market average over the 1-2 year period?
They’d be sensible to expect less but, under the conditions you’ve described, maybe close to it. Because their diversification will probably not be quite as good as a broad-based index, you would probably expect a bit more volatility. Depending on when you take your performance measurement, that volatility might mean they look like they’ve overperformed or it might look like they underperformed.
It’s educational to call in and listen to a company’s quarterly conference call after they announce earnings. The analysts that cover the company are invited to ask questions at the end, and it’s helpful to understand what their concerns are. Hearing those questions, and the answers, are useful to understanding how a company works and is valued.
My financial planner (a good guy, but you do have to check up on him from time to time) tried to sell me on a mutual fund from a money manager who had something like a 25% ROI over 10 years, much better than the market as a whole.
So I looked this fund up.
Eight years before, this money manager had had a spectacular year - all of his bets must have come in at once, he had something like an 80% ROI. Thereafter, money started flooding into his fund, and his performance regressed to the market as a whole - though starting from a higher baseline on the %ROI chart, so it still looked more impressive than the comparison index. But he had basically been operating an index fund for the last six years, though with much higher expenses.
I wasn’t cynical enough to find if he had had some other funds during his miracle year that bet in other directions and ended up getting closed, but I did tell my planner to look for something a bit cheaper.
A good practice, especially with the good guys. People don’t tend to look too closely at the behavior of the people they like. It means that likeable people have the best chance of getting away with scummy behavior.
I don’t know the particular fund you were looking at but there is something referred to in the industry as survivorship bias, which is sometimes exploited by the industry. Survivorship bias is the tendency for mutual funds and hedge funds to look like they consistently outperform the averages but it’s really a function of the worst funds failing and closing, and thus being excluded from the averages. Advisers can exploit this bias. An adviser launches ten funds with a few dollars in each of them. They will each have a a clear investment thesis and be a bit concentrated (although, generally still meeting the definition of “diversified” under the Investment Company Act). Then, they watch what happens. Roughly half will outperform in the first year. They kill the losers and continue with a similar strategy with the remaining funds. Year two will end with two or three funds having outperformed two years in a row. By the end of year three, one fund will have outperformed three years running. That fund now has a solid three-year track record to sell to investors. If it did well enough in that first year, the five and ten year numbers will still look pretty good even if all it does is track the market from then on.
You may not reasonably be able to “expect” such a return; but sometimes a particular company will have a spectacular year in terms of its stock price. It is not at all unreasonable to think that some well-known company somewhere out there will meet such an expectation.
Example: Cigna, which has had a truly fantastic 2022.