Tutorial: read an analyst price target properly
The target is not a forecast of the price. It is a summary of an argument, and the argument is the useful part.
Extract the information from an analyst note without outsourcing your judgement to it.
How read an analyst price target properly works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
The order matters more than the maths
Cheapness is the last question. Ask it first and you produce a list of companies the market has given up on, and it is usually right.
- 1
Know what the rating scale actually means
AnalystsThe distribution of ratings is famously skewed towards buy. A 'hold' from a sell-side analyst frequently means what an ordinary person would call 'sell', and an actual sell rating is rare enough to be notable in itself.
Analysts need access to management. Management does not grant access to people who publish sell ratings. That incentive shapes the distribution, and everyone in the industry knows it.
- 2
Look at the spread, not the mean
AnalystsThe average target is the least interesting number. The range is where the information is. Targets clustered tightly mean a consensus view and little disagreement to exploit. A wide range means the analysts genuinely disagree, and that is where mispricing lives.
- 3
Read the assumption, not the number
Every target is a model output. Somewhere in the note is the growth rate, the margin and the exit multiple that produced it. Those three inputs are the entire argument. If you disagree with one of them, the target is irrelevant to you, and now you know exactly why.
- 4
Remember targets follow prices as much as they lead them
Targets are revised upward after a share rises and downward after it falls, far more often than the reverse. As a predictive signal they are weak. As a summary of the current consensus assumption, they are genuinely useful, which is a completely different job.
Ordinary. The market expects steady, unremarkable growth.
You can state the growth and margin assumptions behind a target, rather than just the number.
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The target is not a forecast of the price. It is a summary of an argument, and the argument is the useful part.
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