Are Target Prices Important? - Investment Ideas
February 16 2012 - 7:00PM
Zacks
Recently, my family has developed an interest and aptitude for
archery. This could have something to do with our shared fondness
for the Elves in
Lord of the Rings, but I've found it to be
a genuinely compelling sport that involves a fair amount of art and
technique. This past weekend, we spent the better part of an
afternoon at a Junior Olympic training session, where target
archery was at its best. While there, I had some time to ponder the
target. I got to thinking: "Obviously, the target is the focus in
archery, but are target stock prices set by Wall Street analysts
useful in picking stocks?"
For some time now, I've wanted to test the effectiveness of
target prices in picking stocks, but I haven't had the historical
data available. Well, now I have access to that data and more via
the Research Wizard, which contains over 600 corporate and stock
data items. Target prices are one of many pieces of information
provided by Wall Street analysts. Other examples of analysts' data
and how to use them can be found by clicking here.
So what's the deal with target prices? Are they useful in
indicating a stock's future direction? How should one use them in
analyzing a stock? Let's try to uncover the answers to these
questions.
Looking at the period from 2000 to 2011, I began with a universe
of the 3000 most liquid stocks, and tested the ratio of the target
price divided by the current trading price. Perhaps the stocks with
the highest values (target price is much higher than current
trading price) still have lots of room to move while those with low
values (target price is below current trading price) are probably
due for a correction. At least that's the theory.
I divided the target/trading price ratios into five equal
buckets (approximately 600 stocks in each bucket) with bucket #1
containing the highest values and #5 containing the lowest values.
The tests were done for each bucket to determine the average annual
return an investor might expect per bucket. So what do the tests
reveal? You should probably be sitting down for this.
The above results show that the bucket that had the highest
target/trading price ratios (#1) had the lowest return at -0.1%.
Therefore, you should NOT buy the stocks that have a target price
significantly higher than the current trading price. You probably
also should avoid the stocks that had the lowest ratio of
target/trading price (#5). Ideally, you want to buy something in
the moderate range (#2 to 4) with a target price about 5-15% above
the current trading price.
These results are contrary to our initial belief that it's
better to have a much higher target price when compared to the
current trading price. But there's often too much optimism and not
enough reality built into expectations. So the expectations, or
target prices in this case, are too lofty and most are never fully
realized. Also, if the target prices are too high, it probably
indicates the stock is over-hyped or "glamorous." As you may know
by now, it rarely ends well for glamour stocks. Moderate
expectations seem to be the best pathway to profitable stock
returns.
Because momentum is playing such a big part in the market at the
moment, let’s continue building on that theme by adding those
stocks within the best range of their target price:
- First, start with only US common stocks.
- Next, create a liquid, investible set of the stocks with the
largest 3000 market values and average daily trading volume
greater than or equal to to 100,000 shares (if there's not
enough liquidity, it'll be hard for you to trade).
- Select only those stocks with a Zacks Rank less than or
equal to 3. (Let's avoid the worst rated stocks.)
- Add another filter that only selects stocks that are
currently trading within 10% of the target price. (Recall we
want stocks that have reasonable and reachable targets.)
- Choose only the top 20 stocks with the best 52-week price
change. (We're looking for winning stocks over the last
year.)
- Pick the five with the best price change over the last 12
weeks. (We also want them to be doing well over the last 3
months.)
Here are five stocks using the above methodology (2/17/12):
V – Visa Inc.
Visa, a payments technology company, engages in the operation of
retail electronic payments network worldwide. The company's target
price is at $123.47 and is within a very reachable distance
compared to its current price. The earnings reported this week came
in above expectations and its strong cash balance has enabled the
company to buy-back shares. Furthermore, Visa expects its 2012
earnings to grow over last year's. This company is also rated a
"Strong Buy" by brokerage analysts.
PRIM – Primoris Services Corporation
Primoris, a Dallas-based company that's a specialty contractor
and infrastructure company, provides a range of construction,
fabrication, maintenance, replacement, water and wastewater and
product engineering services. This company has an average broker
rating of "Buy" and a Zacks #1 Rank (Strong Buy). Its current stock
price is below, yet close, to the target price of $17.66. This
company continues to announce new contracts (adding another $40
million two weeks ago) and reported record profits in November.
CBS - CBS Corporation
This New York-based company's current stock price is in range of
its $32.41 target and is highly rated among Wall Street brokers and
on the Zacks Rank. The earnings report this week showed moderate
increases in both earnings and sales. Price momentum looks very
strong and the stock is up considerably over the last four months.
CBS operates as a mass media company in the United States and
internationally.
YUM – YUM! Brands, Inc.
YUM operates as a quick service restaurant company around the
world. The company develops, operates, franchises and licenses a
system of restaurants including KFC, Pizza Hut, Taco Bell, Long
John Silver's and A&W. This company is rated as a "Buy" by
Street analysts and has had a string of earnings surprises and
estimate revisions. The stock of this company has seen a recent
surge in price, yet is still within striking distance of its $70.05
target. I've never been to China, but I guess they love KFC there
because YUM Brands has seen tremendous growth in the Land of the
Sleeping Dragon.
WYN – Wyndham Worldwide Corp.
Wyndham, together with its subsidiaries, provides various
hospitality products and services to individual consumers and
business customers in the United States and internationally. This
company is rated a "Strong Buy" by all eight of the brokers
providing coverage and is a Zacks #2 Rank (Buy) as well. The target
price of this company is a modest 8% over its current trading
price. This is another company that has initiated a share buy-back
program and that's usually a sign the company believes its stock is
under-valued.
These five stocks are a good start. Now if you remember my
previous article "How Many Stocks Should You Own?" I justify at
least a ten-stock portfolio. So I encourage you to click here to
learn more about the screening and backtesting power of a stock
research system built for the individual investor. With this tool,
you'll be able to perfect your aim and discover additional stocks
to add to your portfolio. You'll also be able to take target
practice on non-live portfolios and, once you've honed your
technique, you'll be able to trade live with confidence.
So summon your inner William Tell for stock picking and visit
this site today!
CBS CORP (CBS): Free Stock Analysis Report
PRIMORIS SERVCS (PRIM): Free Stock Analysis Report
VISA INC-A (V): Free Stock Analysis Report
WYNDHAM WORLDWD (WYN): Free Stock Analysis Report
YUM! BRANDS INC (YUM): Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research
CBS (NYSE:CBS)
Historical Stock Chart
From May 2024 to Jun 2024
CBS (NYSE:CBS)
Historical Stock Chart
From Jun 2023 to Jun 2024