The Folly of Target Prices

Looking at the dearth of analysts reports being churned up daily, one can only wonder about the accuracy of such forecasts and predictions. I had commented once before previously about the utility and usefulness of analyst reports, since most of the time brokerages are being paid to produce churning in shares. Remember that the more churning of shares there is (i.e. frantic buying and selling, contra, short-selling and punting), the more money brokerages (not the retail investor !) will make. Brokerages thus have a vested interest in writing such reports, even though on the surface it would seem that they are "helping" investors by recommending what to buy and sell.

What I must add is that the analysts themselves are not to be blamed; most of the time they take instructions from their bosses who are eager for a report to be written so as to “promote” a particular company. This in turn can create an “avalanche” effect as other brokerages also jump on the bandwagon to issue reports on the same company, thus creating a domino effect on prices. For better or worse (usually worse), punters and speculators will jump on every newly released report as a sign that it is the “next hot tip” and that the stock will either move up or down by 10-20%. Exacerbating this problem is that fact that almost all (95%, with the exception of some OCBC) research reports come with target prices for companies.

What is my issue with target prices ? If you noticed for my previous postings, I do not mention or bother about having target prices for the companies I own. A business is dynamic by nature and the concept of having a target price simply implies that there is already a set PRICE at which one has targeted to sell, which actually contravenes value investing principles. Recall my previous posting about “Knowing When To Sell”, where I mentioned that a value investor would sell under four stringent conditions involving the judgement of the intrinsic value of a company, or if fundamentals were eroded to such an extent that no margin of safety exists. The very act of setting target prices for buying and selling seems to imply that the reports are heavily price-driven, instead of being driven by the underlying fundamentals and prospects of the company.

This is the chief reason I do not bother about target prices for selling or exiting an investment. If one has intimate knowledge about a business and knows the future potential of a company within an industry, the cue to sell would only come from a slowdown in the industry (an erosion of fundamentals) or an errorneous judgement call with respect to the intrinsic value of a promising growth company. After all, the intrinsic value of a company changes almost daily as business activities within the company are in constant motion and change, so how can one comfortably settle on a price for a company on any given day, let alone a “one-year price target” preached about by so many brokerage firms ? The entire world out there is so price-centric that most people would rather ask about a company’s share price BEFORE asking about the company’s principal business, target customers and profit margins. It is this pervasive and persistent focus on price which we have to avail ourselves of before we can drill down into the true value of an outstanding business; as value investors we should strive to be business analysts, and not price analysts.

Thus, one should look at analyst reports for the possible insight into the business fundamentals and assumptions used by the analyst in projecting earnings flow. Since analysts do have better access to company resources and can meet up more regularly with company Management than the average retail investor, this does give them more insights into the business and latest assertions made by Management. All one needs to do then is to ignore the target prices set by analysts and absorb the facts; this will then make reports useful and eliminate the price-centric bias.