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Welcome to the 26th edition of the Tech Financial Planning (TFP) newsletter
A prospect refused to sell his company stock because all the analysts said the stock would go up another 25% in the next 12 months.
Enter 2022 - the value of the stock dropped over 50% and cost them over $500,000
In this newsletter, we’ll break down why I believe price targets are useless at best and how they can lead to poor investing decisions
TL;DR
Price targets sounds great on paper
In practice, they don’t serve much of a purpose, particularly for the long term investor
They are often wrong, both in the upside and the downside
A Background For This Newsletter
This post is inspired by a conversation I had with a prospect in the fall of 2021.
At the time, they had a big concentrated position (roughly $1.2M) in a big tech company, and for a number of reasons, I believed it made sense to sell a good chunk and diversify.
However, they couldn’t pull the trigger to sell some because all the price targets were significantly higher than the current price.
If you are unfamiliar with price targets, they are “a price at which an analyst believes a stock to be fairly valued relative to its projected and historical earnings.”
In this prospect’s case, put simply, all the experts anticipated that the stock still had significant room to grow.
Since then, the price of that stock has fallen ~50% (like many tech stocks), and the value of his position is likely around $550,000
And so I wanted to write this because I find price targets dangerous.
Why price targets suck
In theory, investing based on a price target sounds great.
Look for a stock with a big difference between the current price and the target, buy it, then sit and wait for it to hit the target.
Easy peasy.
Rinse and repeat on your way to wealth.
Unsurprisingly, investing is not that simple nor that easy.
Price targets are not the be all end all of investing.
Here’s a few reasons why you should beware price targets
They are short term focused
Most price targets are 12 months out.
As long term investors, we should be focused on the next 5-10 years, if not longer.
They don’t account for the future
This goes back to my frustration with market forecasts.
In a perfectly known world, forecasts would be super helpful.
But like market forecasts, price targets don’t account for the unknown.
When analysts made their price targets in the beginning of 2022, they didn’t (and couldn’t) account for inflation, the war in Ukraine, and a bear market.
But that’s precisely what happened!
They are Potentially biased
These reports are not objective or impartial.
It's a game - these analysts work for trading houses and investment banks, and these companies make money by providing investment banking services to companies (underwriting debt issuances, underwriting equity issuances, advising on M&A, etc.)
If you're an analyst with a "Hold" or "Sell" rating on a company you cover, and that company decides they want to go out and issue a bunch of bonds, guess what?
The company certainly isn't giving you the business.
They're going to the analysts who are trying to help their stock with "Buy" ratings.
There's zero ethical wall between research departments and investment banking departments (even though legally there's supposed to be.)
A personal favorite is seeing something along the lines of "D.A. Davidson to help company XYZ underwrite $150M bond offering" and then one week later "D.A. Davidson initiates company XYZ at a 'Buy' with a $X price target."
they are Often wrong
“A 2012 study of more than 11,000 analysts from 41 countries, the overall accuracy of target prices is not very high, averaging around 18% for a three-month horizon and 30% for a 12-month horizon” (from this article).
I don’t know about you, but the only time I’m ok with 30% accuracy is a baseball batting average.
Note: This same article - “these analysts may be subject to greater conflicts of interest, because of both personal and business considerations such as their firm may want the underwriting business. As a result, they may tend to provide more optimistic recommendations.
Examples of price targets gone wrong
It’s this last point that I’d like to dive deeper into. They are often wrong, both on the upside and the downside. Here are some notable examples:
Bear Stearns - From December 2006 through its sale to JP Morgan Chase in March 2008, price targets for Bear Stearns remained significantly inflated, even as the company spiraled out of control.
Enron - In the beginning of 2001, Enron traded at $79.75 and two analysts gave an “attractive” rating and a $98 one year price target.
Not surprisingly, that one didn’t work out. By December of 2001, Enron had declared bankruptcy
Amazon - Back in 1998, an analyst gave Amazon a $400 price target when the stock was still trading in the 200s (note, there have been several stock splits since then.
Could you imagine if you had sold at $400? Since that original price target was made, a $10,000 investment in Amazon would be worth roughly $400,000 today
Apple- In 2004, UBS had a ~$1 price target for Apple (again, several stock splits since then).
And if you sold at that price, you clearly missed out on a ton - as of 3/3/2023, Apple traded for $151.03!
Putting it all together
I think price targets are useless at best, and harmful at most.
They can cause people to make (or not make) decisions based on some expert opinion that is dubious at best.
As long term investors, we shouldn’t base trading decisions on short term price targets, unless they align with our goals and our plan.
These two should drive our portfolio decisions, not the other way around.
As one advisor said, “I think investors who use them to the last detail — as in when to sell or not sell — are doing themselves a disservice.”
I agree.
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