Ideas Farm: Target down

Analysts’ target prices, like most market predictions, have been found wanting in recent months.

This should never be a surprise in a bear market, given that investment banks and brokerages are usually incentivised to be bullish about the near-term prospects for stocks. But the scale of the errors in their collective price forecasting shows that even investment professionals can struggle to gauge the near-term outlook for asset values.

Despite this, there are few signs that their optimism is fading.

The FTSE 350 started the year with City analysts predicting its price would rise 15 per cent. Since then, the index has dropped 8 per cent, and the average target price has climbed nearly 5 per cent. As a result, analysts see fair value at a 30 per cent premium to today’s trading price.

The gravity of the declines in the S&P 500 has forced a bit more of a downward revision. The proportion of reports rating the index as an outright ‘buy’ may have dipped slightly, from 50.3 to 47.7 per cent. But even as the median target price has slipped 6.7 per cent, the implied return from analysts’ consensus target is 26 per cent, up from 10.5 per cent at the start of the year.  

Of course, noting that a herd view both got it wrong and has since got more optimistic even as the market backdrop has darkened, is both cold comfort and unrevealing.

Equally, identifying instances of analyst vindication – pessimistic target prices for stocks which proved directionally accurate – is a self-fulfilling exercise. In any case, the lowest of low-ball targets have proven too dire for even this bear market.

We can tell this from a quick scour of our early year feature on the subject (see ‘Prime Targets’, 27 January), in which we picked out a number of price target extremes across the analysts covering UK and US blue chips. In the FTSE 350, only three of the 10 harshest value assessments – Jefferies’ calls on TUI (TUI) and Marston’s (MARS) and Morgan Stanley’s bearish view on Ocado (OCDO) – have been realised. The rest have proved too bearish even in the current trading environment.

Other trends from the companies mentioned in the piece only tell us so much. In the UK, stocks with the greatest herd optimism – those with the greatest mean target price premium to the current price – have on average performed worse than those where the typical analyst expected a 12-month drop. The pattern is repeated with stocks with the highest individual target prices.

Does this suggest investors are more prone to mark down would-be stars when things go wrong? It’s possible, although the sample size and background volatility should stop us from drawing conclusions too readily.

That said, it is interesting that the worst-performing group of stocks in both the UK and the US were those where analysts’ target prices showed the greatest divergence. In the FTSE 350, all 10 of the stocks with the widest target price spreads have underperformed the market since 17 January, and by 41 per cent on average. Among the top 10 US blue chips in this category, only one stock – Israeli solar panel group SolarEdge Technologies (US:SEDG) – ended the period in positive territory, and all but two fared worse than the S&P 500.

Might the widest disagreements on a stock’s value in fact be a more reliable bear signal than the average or extremes? Again, it’s hard to say, although for those who are interested, here are the 20 stocks across both markets with the widest target price spreads – provided without comment.