Price Targets Are the Weakest Part of an Analyst Note

An analyst note is mostly estimates, model tables, industry detail and a list of risks. The part that escapes onto quote pages and headlines is a rating and one dollar figure. That figure is the weakest thing in the document.

A target is the output of a model. The judgment lives in the model’s inputs, and once those inputs are stripped away you are holding a number that can’t tell you whether it is right, why it moved, or how confident the person who wrote it actually was.

A target is two assumptions multiplied together

Most targets reduce to one sum. Estimate future earnings. Pick a multiple. Multiply. Some analysts use a discounted cash flow model instead, which has more inputs and the same weakness, since the growth rate, the margin path and the discount rate are all choices the analyst makes and the reader rarely sees. The horizon is usually around twelve months. Notes vary, so check.

Two very different changes produce the same $54. In one, the analyst still expects the company to earn $3.00 and has simply decided investors will pay less for it. In the other, the analyst expects the business itself to earn ten percent less. The screen shows $54 either way. Every fair value estimate is a stack of assumptions, and a price target is that stack with the working hidden.

The parts of a note that carry information

Three sections beat the target.

Estimate changes come first. When an analyst raises next year’s revenue and earnings forecasts after a meeting with management, that is a claim about the business, and you can hold it up against the company’s own outlook and guidance to see whether the analyst is ahead of the company, behind it, or simply repeating it. Watch the direction. Watch the size. An estimate cut paired with an unchanged target means the multiple went up to fill the gap.

The reasoning comes second. Why will margins widen? Why will a product line slow? A good note names the driver and the evidence.

Then the risks. This section is often the most candid part of the note, because it lists the ways the call could go wrong. Read it slowly. Sometimes it makes a better case for the other side than the analyst intended.

Targets tend to follow the price

Watch a stock after a sharp move. Targets often get revised afterward, in the same direction.

The stock rallies, and over the following days analysts lift their targets toward the new price. The stock falls, and targets drift down behind it. From the analyst’s chair this is understandable, since a target far below the current price looks stale and a small change to the multiple can justify almost any price, but from yours it means a target raise after a rally mostly describes something that already happened. You had the price already. It was on the screen.

A consensus target averages models that disagree

Many quote pages show a consensus target. It’s an average. The inputs are targets built on different estimates, multiples, methods and horizons, each updated on its own date.

Suppose three analysts cover a hypothetical stock with targets of $45, $60 and $75. The average is $60. Three targets of $59, $60 and $61 also average $60. One case is a real argument about the business. The other is near agreement. The consensus figure makes them identical, and it does so in exactly the situation where you most need to know how uncertain the outlook is, since a wide spread of targets is itself a statement that nobody has much confidence in the earnings.

So look past the average. Find the high target, the low target and the count of analysts. Most pages put them near the consensus figure. The walkthrough on reading analyst ratings shows where they usually sit.

Where the argument stops

A big target change with new reasoning is news. Say an analyst cuts a target by a third and explains that a large customer contract is at risk, or that a new product is selling well below plan. The number is now a summary of a real finding. Go read what was found.

A target that moves against the price deserves a look too. A raise after a fall, or a cut after a rally, is an analyst disagreeing with the market on purpose. It says someone has a view, and the note will usually explain it at more length than a routine update would.

Reading a note in the right order

When a new note lands, or a headline reports one, work through it backward from how it is presented.

1. Find the estimate table and compare this quarter’s forecasts with the previous ones.
2. Read the paragraph that explains the change. If there isn’t one, the change is probably mechanical.
3. Read the risks, and mark the one you think most likely.
4. Only then look at the target, and work out what multiple it implies on the new estimate.

That last step is quick arithmetic. Divide the target by the estimate for the period it covers. If a $60 target sits on a $3.00 estimate, the analyst is assuming the stock trades at 20 times earnings a year from now, and you can ask yourself whether that multiple is reasonable next to the stock’s own history and its closest competitors, which is a question you can answer with public data and without any access to the analyst’s model.

Most of the time the answer is unremarkable. The multiple is close to where the stock trades now, the estimate moved a little, and the target moved with it. That note told you about the estimate. The target was along for the ride.

Everything else can wait. Read the estimate revisions and the risks first, then look at the target and ask what it adds.