Episode #29- The Value of Research Analysts and Price Targets

Wealth Decisions Podcast Transcript for Episode #29- The Value of Research Analysts and Price Targets

Listen to this episode on Apple Podcasts or Spotify

Welcome to The Wealth Decisions Podcast, where each week I take 15 minutes or less to discuss crucial wealth decisions and mindset hacks to help you live a richer life.

I'm your host, Brian Muller, and I've been in the financial services industry for over 25 years, and I'm also a certified life and health coach.

And I have a passion for helping people make better decisions around their money and their life.

So for the sake of time, let's dive right into it.

In today's episode, we're going to explore a topic I think is really crucial for anyone to understand when investing in individual stocks.

And that's the value of research analysts and price targets.

You know, whether you're a seasoned investor or just starting out, you've probably come across stock price targets in the financial news or brokerage reports.

But have you ever really wondered who sets these price targets and how they're determined?

That's exactly what we're going to be talking about today.

So let's just start with the basics.

Research analysts, also known as equity analysts or stock analysts, and we also have analysts in the fixed income arena.

These are financial professionals who study publicly traded companies and their individual stocks.

They usually work for investment banks or brokerage firms or asset management companies.

And they provide valuable insights to both individual investors like ourselves or institutional firms.

And these analysts typically specialize usually in a specific sector or industry, which allows them to really develop deep expertise in that chosen area.

For example, you might have an analyst who focuses solely on technology stocks, while others might concentrate on the health care industry or energy companies.

And the primary job of a research analyst is to gather and analyze financial data, study industry trends and the competitive landscape.

And they'll also create financial models to forecast a company's performance.

And they'll typically make recommendations on whether to buy, hold or sell a stock.

But they also will set some type of price target for the stocks that they cover.

So let's talk just a little bit about the value of price targets.

A price target is an analyst's projection of a stock's future price.

And they usually look over a 12-month period.

And it represents kind of the analyst's best estimate on where the stock could potentially be based upon their research.

And price targets are typically expressed as a specific dollar amount.

For instance, an analyst might set a price target of $150 for a stock that's currently trading at $100.

Suggesting they believe the stock has the potential to rise about 50% over the next year.

But one thing to note about price targets is they're not guarantees.

They're educated guesses based upon thorough analysis.

But many factors can influence stock prices.

And even the most skilled analysts can't predict the future with complete certainty.

So how do these analysts arrive at these particular price targets?

At first, they look at fundamental analysis.

So that's going to look at a company's financial statements, income statements, balance sheets and cash flow.

And they look at key metrics such as revenue, growth, profit margins, debt levels and return on equity.

And the second, they have some type of valuation model.

They'll use some financial data and they'll build these complex financial models to value the company.

And they'll usually look at methods like a discounted cash flow analysis or price to earnings ratio comparisons or even enterprise value ratios.

Then, they'll look at the industry that that particular company is in.

And they'll look at broader trends, the competitive landscape, and maybe potential regulatory changes that could impact the company's performance.

Number four, they'll look for kind of macro economic factors that might impact those companies, such as interest rates, inflation, or just general gross domestic product.

Then, they'll look at company guidance.

Many companies will provide some type of forward-looking guidance on their expected performance.

And analysts will take this into account, but may adjust kind of their expectations based upon their own due diligence and research.

And then, they'll look at qualitative factors like the management quality.

A lot of these analysts will sit down in boardrooms with sometimes the CEO or high-level management.

And they'll find out kind of what the strengths are, the innovation pipeline and things like that.

And they'll kick the tires firsthand with management to be able to make better decisions on where they think the company can go.

And after weighing all these factors, the analysts will use their judgment.

And these models that they come up with to determine some type of price target that they believe kind of accurately reflects the stock's potential.

Price targets can be really useful tools for investors.

It provides just a quick snapshot of an analyst's outlook on a stock.

It can help you identify potentially undervalued or overvalued stocks.

But it's crucial to understand the limitations of price targets.

Number one is there's some subjectivity involved.

Despite this rigorous analysis that these analysts go forth when analyzing a company, price targets ultimately involve some type of subjective judgment.

Number two, most price targets are set for a 12-month period, which may not align with your investment timeline.

But it gives you an idea of the potential upside of a company over the next 12 months.

Number three, there's always changing conditions.

Market conditions and company performance can change rapidly, potentially invalidating those price targets.

And number four, sometimes there can be a conflict of interest.

Some critics out there maybe argue that analysts may face conflicts of interest, particularly if they are at a firm that has a business relationship with a company they're doing analysis on.

Number five, sometimes there's herd mentality.

So a lot of analysts may be influenced by their peers, leading to kind of a cluster of price targets.

So there's some limitations, but it's essential for investors to use price targets as just one tool in their decision-making process rather than relying on them exclusively.

So if you're going to invest in individual stocks and you are looking at price targets and to help you make decisions, one thing to keep in note is always consider multiple analysts.

Look at price targets from several analysts to get a range of opinions.

It's not always the same.

Every analyst might have a completely different outlook on a particular company.

So, it's important to look at multiple analysts' opinions.

Number two, look beyond the number.

Read the full research report to understand the analyst's reasoning.

I know a lot of us don't have time to sit and read 10, 15, 20 research reports.

But if you are going to invest a substantial amount of money in a company, you need to do a little bit of your own due diligence.

Also, it's really important to check the date of the analyst's report.

Most things nowadays are very updated with the internet, but make sure you're looking at the most recent price target, as some of those older ones will probably be outdated.

And also compare your own analysis.

Use price targets as kind of a point of comparison with your own research.

And if you know how to value a company, there's different ways to do it.

There's different calculators out there that can help you do that.

You know, compare your own analysis to what these analysts are projecting for companies.

And like I said before, you know, be aware of the conflicts of interest.

You know, be aware of the biases.

Remember that some analysts may have biases towards that company.

And also, always consider kind of the big picture.

You know, don't make investment decisions based solely on one thing.

And price targets are a useful tool, but it shouldn't be the only reason why you buy a stock.

I've always looked at the past as a guide.

When I see a lot of analysts putting very far out price targets on companies, that starts to set an alarm in my head that maybe there's too many people that are bullish on a particular stock.

I can remember back in 1999, during the tech boom, one of the Wall Street's darlings was a company called Qualcomm.

And at the time, they had patents on 3G chips.

And here we are today at 5G, but back then, that was the new chip.

And there were many analysts that put pretty ridiculous price targets on Qualcomm.

Looking back at that, in hindsight, that was kind of the end of the tech boom.

And many of those companies that had high price targets, especially in the technology arena, came crashing down during the tech bust of March of 2000 and beyond.

So don't just rely on price targets.

If the price target seems somewhat ridiculous, like I've seen price targets by Kathy Wood, who has been a big believer in Tesla, she has a price target that seems pretty ridiculous.

You have to look at where a company is and what its potential is in the next 12 to 24 months.

And putting price targets that are four or five times the value of a company seems to be a little outrageous.

So be aware of some of the ultra bullish analysts.

And don't make that as a reason why you should buy a particular stock because there's a two or three analysts that have really, really high price targets.

A recent example of this is NVIDIA, which is kind of the Wall Street darling right now in the AI space.

It's done very, very well, has unbelievable metrics.

When you look at all the metrics involved in value in a company, profit margins are some of the highest in the chip industry and in the tech industry.

But there, it's a crowded trade right now.

Everyone wants to get in.

There's FOMO, nobody wants to miss out on this AI boom.

But when you have analysts with price targets that are way above where the stock is trading at, that sometimes is a cause for alarm.

Don't just look at price targets and say, well, I'm going to overweight, I'm going to put 20 or 30% of my nest egg in NVIDIA because so-and-so says that it has 70% upside over the next 12 months.

That's a rich, rich company.

It's trading for perfection.

Very well positioned, but it's not something that you should bet the farm on.

No matter how great a company is, always take into account how it fits in your overall financial picture and whether it's going to help you reach your financial goals.

Research analysts and price targets do play a significant role in the stock market kind of ecosystem.

They provide valuable insight, but it's crucial just to understand both the strengths and limitations of analysts' target price projections.

Just remember, successful investing is about more than just chasing performance or chasing price targets.

It involves thorough research, it involves a well thought out strategy and the discipline to stick to your plan even when the markets get turbulent.

I hope this episode has given you a deeper understanding of research analysts and price targets.

And as always, if you have any questions or topics you'd like me to cover in future episodes, please reach out through my website at momentouswealthadvisors.com.

And that's it for today's episode, Understanding Research Analysts and Price Targets.

Listen to this episode on Apple Podcasts or Spotify


-Brian D. Muller, AAMS® Founder, Wealth Advisor

Momentous Wealth Advisors in a fee-only fiduciary advisory firm

Disclaimer: This material is for informational purposes only and should not be construed as investment advice. Past performance is not indicative of future results. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

Investors should understand the risks involved in owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Always consult with a qualified financial professional before making any investment decisions.