Broker Price Targets: Worth Following Or A Trap?

20th Feb by Alex Naamani

9 comments 1357 reads

Many readers will know Warren Buffett as one of the world’s top investors. The Oracle of Omaha strikes us as sharp, witty and don’t forget he has a photographic memory. Many people buy a stock just because Buffett bought the very same stock. But fewer people realise that this blind, unquestioning faith in heroes once got him into a spot of bother… way back in 1950. At the time, Buffett idolised Ben Graham and David Dodd, the founding fathers of value investing. He had memorised their textbook, Securities Analysis, and later admitted, ‘I knew the book even better than Dodd.’

Warren was still a student at Columbia, networking to improve his job prospects. Through a chance encounter, he found himself having lunch with a man called Lou Green, one of Ben Graham’s business associates. They bounced investment ideas.

Lou Green asked, ‘Why did you buy Marshall-Wells?’

Warren replied, ‘Because Ben Graham bought it.’ Then his stomach churned. Warren later recalled: ‘I’ll never forget the way he looked at me.’

There was a long pause, then Green said: ‘Strike one!’

Buffett was with this impressive character, and then all of a sudden he was ‘striking’ out. The key lesson is this… You have to think for yourself! Blind faith in heroes had led Warren to make the faux pas.

Does every Padawan need a Jedi Master?

We should perhaps be a little more forgiving towards Warren. Having a mentor is essential, especially when starting out. Movie lovers will know that every Harry Potter needs a Dumbledore. Every Luke Skywalker needs an Obi-Wan Kenobi.

Investing, particularly private investing, can be a lonely business. We do not have direct access to Warren Buffett or the stock-market equivalent of Dumbledore. So when I started out, the “experts” I gravitated toward tended to be brokers. Their recommendations were structured in a way that was easy to understand. I looked at brokers’ price targets and made one of two conclusions:

If a stock was trading at a discount - i.e. below the broker's target - I assumed brokers were optimistic and bullish. I saw a buying opportunity;

If a stock was trading at a premium - i.e. above the broker's target - I assumed brokers were pessimistic and bearish. I saw a selling opportunity.

Everything seemed clear and actionable. I absorbed broker targets with the same level of trust as someone following…

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descartes244238

21st Feb

Thank you. You have confirmed what I thought of brokers and their fairy land targets. When a stock has a rating by 2 brokers on the same day; one saying strong buy, the other a strong sell, credibility went out the window a long time ago. The broker is the reality of experts; 'an ex is something that has been: and a spurt is a drip under pressure'.

Alex Naamani

Glad you enjoyed. I guess the trick is to distinguish between experts and experts. Obviously, a world without specialists would be complete and utter anarchy. At the same time, there is no substitute for a little doubt and a little skepticism, as your namesake, Descartes, pointed out!

chris2021

My SIPP has a potential 34% upside based on my calculations and projections, whilst the aggregate of brokers is 76%. A similar trend exists on the other portfolios. The history of my portfolios tells me I'm optimistic in my projections.

Lolarose

A great article and confirms my own thoughts on brokers, long before the day of the internet and of being able to do wider searches there was more reliance on brokers tips. I developed a pattern of going the opposite direction of what they say, I must say it has held me in good stead being a self taught novice investor of 45 years.

Thank you for the article

iwright7

Alex, A super and thought provoking article that lays bare the risks of believing analysts’ recommendations.

Coincidentally there is a podcast released this week that covers similar ground. In an interview by Steve Chapman, Dan Rasmussen questions the accuracy of analyst forecasting. Controversially Dan’s research indicates that past growth rates of revenue, earnings, or cash flows do not accurately predict future growth.

Dan has written a new book, “The Humble Investor: How to Find a Winning Edge in a Surprising World”, which describes how he manages $1B of assets.

I am always curious about others edge perception , so have just ordered my copy.

Podcast here: https://behindthebalancesheet....

dodge1664

22nd Feb

interesting article Alex. I tried plotting the performance of the stock factor "price target/market price" on the US stock market with the results sorted into 50 different buckets. the time period is 1999 to the present. The buckets on the right are the stocks where the price targets are far above the current price. It seems that bucket 32 does best, where stocks are slightly below the target price. But the extremes are to be avoided, it seems

Hi,

Interesting graphic!

Thanks for sharing.

And I agree: the extremes are to be avoided. As you can see above, the stocks that are generally 'in line' with the target perform better, although I should add that the problem with extreme discounts was bigger than the problem with extreme premiums.

We can see below that discounted stocks (Bullish Broker Target) have far less QVM exposure - e.g. a StockRank of 44, well below 64 and 65. The red flag for extreme premiums (Bearish Broker Targets) perhaps lies in the over exposure to momentum and the under exposure to value. Extreme premiums were maybe dipping into momentum trap territory.

Best,

Alex

WarrantStar

23rd Feb

Alex. Thanks for a very thought provoking piece. The way in which the brokers come up with their share price targets tends to rely heavily on the broker's earnings forecasts. So this strongly suggests that we should 1) Pay little or no attention to brokers' share price targets. 2) Pay little or no attention to brokers' earnings forecasts. Has there ever been any research which examines whether the companies in house brokers tend to produce more reliable earnings forecasts and share price targets than the overall brokers consensus does?

Hey, Good question. It is an interesting angle of research, but we do not have the breakdown to explore it further, unfortunately. We know the average/median estimate and the number of brokers feeding into said estimate, but we have no means to know which broker is making a specific estimate. Otherwise, yes... it would be a great research piece. If I see something like it on the web, I'll post it here.

Broker price targets: Worth following or a trap?

Does every Padawan need a Jedi Master?

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Alex Naamani

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