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Prime targets

Can analysts’ share price targets – both conventional and outlandish – help investors think more carefully about company valuations?
Prime targets

Price targets are among the simplest of investing metrics, but lots can be learned from the way in which they are constructed – and from the outliers in the analyst community who create them. 

Most simply put, a price target refers to an expected future price for an asset or security. In the stock market, and from the pens of analysts, this is typically expressed over a 12-month time horizon.

Let’s take the UK’s largest listed company as an example. Royal Dutch Shell’s (RDSB) ‘B’ shares trade at £18.45, compared with an average broker price target of £23.58. This so-called ‘upside’ – the premium to the current market price where analysts see Shell’s fair value, and which they expect it to reach in the next year – has narrowed in recent months, but it is still a considerable 28 per cent higher than the current price.

At the top end of the range is one £30 price target forecast, equivalent to a 63 per cent absolute implied return.

Usually, targets are how brokerages derive their ‘buy’, ‘sell’ and ‘hold’ recommendations; if an analyst’s price target is, say, 15 per cent above the market price, it is normally considered a ‘buy’.

Because stock markets have a habit of rising over time, and investment banks tend to issue bullish reports about the stocks they cover, price targets tend toward optimism. Indeed, the average price target for a FTSE All-Share stock is 25 per cent above its market price, according to FactSet. That may be because prospects are indeed brighter for UK stocks, or a sign of over-optimism. In the S&P 500 the average premium is 14 per cent; high, but closer to the index’s long-term average annual return.

There are several ways to calculate a price target, but one quick and easy method is to multiply the current share price by the estimated one-year change in earnings. For example, a company whose shares trade at £20, which generated earnings of £1 per share in 2021 and is forecast to make £1.20 this year, can expect to have a price target of £24. Of course, this rather crude example makes lots of assumptions, including the sustainability of earnings growth, and the relative attraction in a year's time of a stock on a current pirce/earnings (PE) ratio of 20.

Price targets are therefore a synthesis of an analyst’s views on a company’s near-term prospects, the long-term outlook for the stock and sector, and investors' appetite to buy into a valuation story. The context is important: most of the analysts covering Shell will derive their price targets from their views on the likely trajectory (and inherent volatility) of oil and gas prices, as well as the company’s own capital expenditure projections (and their historic unreliability).

Although these forecasts vary from broker to broker, analysts do not work with truly proprietary information and must declare any inside knowledge of a company. As such, target prices have a habit of converging on a tight distribution range.

So are they useful? The short answer – as we will explore below – is yes, both as an average figure and at the extremes. Price targets can act as a shadow indicator for share prices, even if they don’t always prove to be reliable predictors of real-world performance.

Sticking with Shell as our example, there has been only one month since the financial crisis (in June 2016) when the market price has exceeded the average price target. Analysts have been perpetually more bullish than the market over the past decade, a period in which the stock has badly lagged the FTSE All-Share on a total return basis. But they also called the bottom in the shares last September, given the average target price was at its highest ever premium.

The growing chorus of Shell bulls would do well to remember those two facts, amid oil’s seemingly ordained rise towards $100 a barrel.


Target down

Sometimes, price targets have another function within markets, particularly when they stray wildly from consensus. The short public trading history of Darktrace (DARK) is a case in point.

Last October, shares in the cybersecurity group were trading at 950p, after a monumental climb from their April debut price of 250p. Analysts at Peel Hunt then called for a “reality check” and a “more grounded approach to valuation” for the high-flying stock and set a price target of 473p. The sceptical note spooked investors and helped to pull the rug from the momentum. The shares subsequently bombed, and have since failed to recover ground, even as forecast losses for the next three years have narrowed. Since then, other analysts have quietly lowered their own price targets, with a nod to the greater leap in market faith now required to recover lost ground (see chart).

The note was also more closely aligned with another way in which price targets are sometimes set. While most investors think about targets with reference to a future, higher market value, some see price targets as the level a stock would need to fall to before they buy or increase their exposure.

This relates closely to the concept of the margin of safety, which Warren Buffett has called the principal of his “cornerstones of investing” and which involves buying when a security’s market price is at a discount to what an investor considers its intrinsic value. In this sense, a target price is whatever margin of safety an investor is comfortable with. It is also most relevant in moments of acute market or corporate stress.


The target market

In the text and tables below, we have screened the FactSet database to identify the most aberrant analyst price targets in the FTSE and S&P markets, both on an individual and average basis. The hope is that by identifying the widest gaps between market and analyst price targets – as well as the widest divergences within analyst opinion – readers will at the very least have a new source of ideas.

There are, however, several caveats and health warnings to consider alongside this data.

First, it’s worth noting that larger investment banks and brokerages tend to coalesce around narrower price target ranges, particularly for the largest stocks. For these analysts, and their rankings among peers, being close to the mark most of the time may be more important than nailing a big call. Their institutions also often act as corporate advisers to the companies, or the big market makers in these securities, and so might have more to lose from taking an outlandish (or, in practice, pessimistic) view of a stock.

By contrast, research-only houses may have incentives to adopt a more extreme or dissenting view of a stock, and an outlier target price to go with it. Particularly when stocks are closely followed, having an outlier view is more likely to garner financial media attention, and an analyst’s contrarian or hyper-bullish view need only be vindicated for them to be hailed for their insight.

GLJ Research’s $67 price target on Tesla (US:TSLA) shares, for example, has helped to make it the poster child for negative analyst opinion on the electric vehicle maker. Incidentally, a consensus target price of $922 – 12 per cent below Tesla’s current market value, just like Ford’s (US:F) own consensus target – suggests analysts are more pessimistic than the market about the stock’s prospects. But they’ve also been routinely wrong to date.

Third, analysts can be slow to update their price targets and forecasts, which may account for some of the disparities. But this shouldn’t normally happen, and efforts have been made to screen out old forecasts. For example, Investec last published its £1.15 on Cineworld (CINE) on 14 December, when the troubled cinema chain’s stock had already fallen to 45p.

Despite all of this, price targets are useful. While blue-chip investors are required to disclose large positions in a company, rarely do they show their working or views on a share’s intrinsic worth. Analysts, by contrast, are forced to convince investors that their targets are worth believing. Their reputation hinges on the accuracy of their market calls. That should count for something.


AO World/Jefferies (306 per cent upside)

AO World (AO) has had a strange pandemic. As Covid-19’s initial market shock made way for lockdown, the online-only electrical equipment retailer appeared to be a prime beneficiary of an acceleration in ecommerce and home improvement activity. Suddenly, the group appeared poised to deliver on its long-held promises and turn a profit.

The combination of rocketing sales and an ecommerce gloss gave the shares a premium rating, and the stock finished 2020 up more than fourfold, peaking above £4.

Then gravity reasserted itself. Faced with strong comparatives, growing competition, and supply chain issues in both the UK and Germany, sales figures for the six months to September 2021 fell short of expectations. Management warned that lower volumes would hit operating leverage, leading to a swing in the bottom line back to a loss.

Despite all of this, one analyst to keep the faith is Andrew Wade at broker Jefferies, who has left his price target on the stock at £4, against a current market price of 99p. Despite this, Jefferies has expressed doubts that a turnaround could be at hand. “Just as the model had appeared to be fixed, a new layer of competitive challenge seems to have emerged,” the group wrote in a note to clients last October, while highlighting “questions to answer regarding international growth aspirations”.

With losses forecast by most analysts this year and next, Numis’s £1 target price looks a surer thing.


Funding Circle/Numis (298 per cent upside)

Like AO World, Funding Circle (FCH) is a UK-listed growth-focused company with a novel proposition and an uncertain future ahead of it, after a two-year period in which its own shares looked turbocharged at times. The peer-to-peer lender’s house broker, Numis, is very bullish on the shares.

Arguably, the investment case is an easier sell than AO World's own, and helps explain why large investors were queuing up to kick in £300m at the group’s initial public offering in 2018. Initially, the group’s platform appeared to offer a solution to both fixed income investors’ hunt for yield and the high underwriting and regulatory bars that cut so many small businesses out of the credit loop.

But growth promises stuttered, profit targets shifted, and it soon dawned on the market that the job of balancing investors’ required returns with credit risk would prove trickier than first impressions. A capital light, speedy borrowing model came to the fore during Covid-19, as Funding Circle participated in the UK and US government’s emergency lending programmes. As those schemes wind up, Funding Circle will need to point to some very powerful green shoots of growth.

The reference point for Numis’s £4.10 price target was originally a £100m net income forecast for 2023, although this has since narrowed to £47m. That might not seem much against an enterprise value of around £400m, but growth is sorely needed.


PureTech Health/Peel Hunt (218 per cent upside)

Investors have fundamentally mispriced PureTech Health (PRTC), according to analysts at Peel Hunt.

The FTSE 250 constituent focuses on the discovery, development and commercialisation of medicines for a range of diseases where there “are currently limited or no options available for patients”. It has 25 therapeutics candidate medicines, 17 of which are in the clinical stage, spread across a range of partnerships with leading universities and pharmaceutical companies.

Its track record has been strong. PureTech calculates that 45 per cent of its Phase I clinical candidates make it to the regulatory filing stage, compared with an industry average of 11 per cent. But biotechnology successes can be lumpy and uneven, and as is common to companies working on multiple breakthrough medicines, arriving at a sum-of-the-parts valuation can be tricky.

In theory, this should get easier with a mark-to-market approach, and the listing of a subsidiary. When Peel Hunt set a price target of £9.30 for the stock last summer, it explicitly referenced PureTech’s 19.2 per cent stake in weight loss treatment specialist Gelesis (US:GLS), and the “announced $1.3bn” valuation of its special purpose acquisition company (Spac).

Applying this multiple to other “soon-to-be-listed” entities, together with a consolidated cash balance of $441m, Peel Hunt arrived at measurable assets of more than $1bn (£730m), which was at the time equal to around four-fifths of PureTech’s market price. The group’s wholly-owned pipeline of medicine candidates and subsidiaries was in the price almost for free.

This assessment was, and remains, very bullish. In the end, Gelesis raised $105m in its SPAC, far short of the $376m it originally forecast when the deal was announced, and is now worth a little over $150m. This doesn’t mean the rest of the pipeline should be so heavily discounted, but it nonetheless shows the difficulty of valuing a loss-making business with no sales.


Hammerson/Jefferies (58 per cent downside)

One well-trodden strategy for picking stocks involves screening for companies which trade at a discount to their audited (or book) value.

In recent years, any investor who applied this approach to the FTSE All-Share is likely to have found Hammerson (HMSO), the retail and shopping centre landlord, near the top of the list. But the margin of safety that remains in the market price is highly contested. Many have concluded that the only way is further equity erosion, the shares having last peaked at £3.47 in 2017.

Among them are real estate analysts, who have also consistently valued the company below its market value. In fact, no other company in the FTSE All-Share has a more pessimistic consensus target price, according to FactSet data. Analysts at Jefferies are firmly in the pessimist camp, and see fair value at 15p a share, three-fifths below the current price.

So, what does the brokerage know that investors – including APG Asset Management, Lighthouse Properties and Morgan Stanley, all of which have been building their stakes in recent years – don’t?

In short, nothing. But real estate analysts will have noted the paucity of liquidity and large assets disposals in the shopping centre market as a worrying portent. In November, Jefferies also pointed out that an attempt to sell the Silverburn shopping centre in Glasgow could fail if joint-venture partner Value Retail fails various borrowing covenants on £1.1bn of unsecured debt.

A refinancing is therefore required, without which Hammerson’s auditor has raised material uncertainties over the landlord’s ability to operate as a going concern. Jefferies’ pessimistic price target is a strong hint that other players could soon hold the cards.