When it comes to evaluating stocks, target prices can be even more useful than the ratings of equity analysts. Strictly defined, a target price is an estimate of a stock's future price, based on earnings forecasts and assumed valuation multiples.This article investigates what people should know about target prices, and how these reports can lead to wiser investment decisions.
Key Takeaways
- A target price is an estimate of the future price of a stock. Target prices are based on earnings forecasts and assumed valuation multiples.
- Target prices can be used to evaluate stocks and may be even more useful than an equity analyst’s rating.
- While opinion-based ratings have limited value, target prices can help investors evaluate the potential risk/reward profile of the stock.
Why Target Prices Are Better Than Ratings
First and foremost, ratings have limited value, because they are opinion based. While one analyst may rate a stock as a “sell,” another may recommend it as a “buy.” More importantly, a rating may not equally apply to every investor, because people have different investment goals and risk tolerance levels, which is why target prices can be so essential to rounding out research.
It should be stated that the quality of a target pricing model is only as strong as the factual analysis behind it. While a shoddy thesis behind a target price can lead investors astray, thoughtfully constructed target pricing models can legitimately help investors evaluate the potential risk/reward profile of the stock.
4 Keys to Target Price
Investors should consider the following four factors in determining the legitimacy of a target price:
Earnings per Share (EPS): A keystone element of the target price, the report should contain a detailed earnings forecast model, including a full income statement with a discussion of operating cash flows for the time frame covered by the target price. A quarterly forecast for the next 12 months is useful for tracking the accuracy of the analysisandevaluating whether or not the company is performing as anticipated.
EPS Forecast Assumptions: The report should also discuss the assumptions used to make the forecast, so readers can evaluate their credibility. Reports that lack detailed earnings models and lists of assumptions should automatically raise red flags. It is important that the assumptions are reasonable.
For example, if a micro-cap company’s sales grew just 1% to 2% over the last two years, it would be illogical to project a double-digit growth over the following two years, unless there is a significant event, such as a new product rollout or patent approval. These game-changers should be incorporated into detailed earnings models so readers can adjust their assumptions accordingly.
Price targets are not necessarily always accurate so an investor should do their own research before investing based on the targets of other analysts.
Valuation Multiples Used to Calculate the Target Price: Target prices rely heavily on valuation multiples, such as price/earnings (P/E), price/book (P/B), and price/sales (P/S). Each valuation multiple should appropriately apply to the stock in question.
For example, the market places more emphasis on P/E multiples for industrial companies, while placing greater importance on P/B numbers for banks. Furthermore, valuation models should rely on a host of different variables. A model based on just one multiple is like a one-legged stool—not sturdy or reliable.
Assumptions Used to Justify the Valuation Multiples Used: Whether they are used to support earnings forecasts or valuation targets, assumptions must always be reasonable. This can be determined by comparing assumptions to historical trends, relevant peer groups, and current economic expectations.
If a stock has consistently traded below its peer-group average, but the forecast projects the multiples to be larger than its peers, it’s vital to investigate why this stock is suddenly expected to outperform. While there may be legitimate reasons behind such projections, such as FDA approval of a new drug, only investors with high-risk tolerance levels invest in such a story.
What to Do When a Stock Hits the Target Price?
When a stock you own hits your target price for growth, reevaluate the stock at the time and determine if it still has the potential to grow further. If your analysis indicates that it will continue to grow, then hold on to it until it reaches your new target price, and if not, then cash out and take your profit.
How Do People Make Money When Stock Prices Fall?
The main way to make money when stock prices fall is to short-sell. The process involves an investor borrowing a stock, then selling the stock, then buying the stock later when the price has fallen, and returning it to the original lender. Stock selling is complex and not recommended for new investors.
At What Percentage Should You Sell Your Stock?
The percentage growth at which you should sell your stock will vary depending on multiple factors, such as risk tolerance and the stock's growth potential. It can be recommended to cash out of the majority of your position when the growth hits between 20% and 25%.
The Bottom Line
Target prices can go a long way in helping investors decide if a stock warrants an investment. A good target price considers a set of four factors. Without all of them, investors should dismiss the target price report outright, as it could be a pump-and-dump marketing ploy.
FAQs
By comparing the target price to the current market price, traders can assess whether a stock is undervalued or overvalued, and decide whether to buy, sell, or hold their positions. Potential gains: Traders aim to gain from changes in stock prices.
What is the key to investing in the stock market? ›
To trade stocks, you need to set clear investment goals, determine how much you can invest, decide how much risk you can tolerate, pick an account at a broker that matches your trading style, fund your stock account, and start trading. It can be a powerful way to grow your wealth over time.
Do stocks ever reach target prices? ›
A 2006 study showed that share prices met or exceeded the price target at some point over the following year for just 53% of observations and only met or exceeded the price target in 30% of cases at the end of those same 12 months.
What is the target price model? ›
What is a Target Price Model. Put simply, the target price scheme means sharing profit with the client when delivering a project below the predefined price, but also sharing costs when the budget is exceeded. This particular type of contract may lead to sharing a pain or gain between two parties.
What to do when stock hits target price? ›
Going forward, when the stock hits your target price, reevaluate it and determine if it has the ability to continue double-digit price gains or if you would gain more by cashing in now and using those funds to purchase a different stock with more potential.
How much money do I need to invest to make $1000 a month? ›
A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.
How much money do I need to invest to make $3,000 a month? ›
Imagine you wish to amass $3000 monthly from your investments, amounting to $36,000 annually. If you park your funds in a savings account offering a 2% annual interest rate, you'd need to inject roughly $1.8 million into the account.
What is the target trigger price? ›
Trigger price is the price at which your buy or sell order becomes active for execution at the exchange servers. In other words, once the price of the stock hits the trigger price set by you, the order is sent to the exchange servers.
How to predict target price of stock? ›
The P/E method multiplies two variables to calculate a stocks price target: A P/E multiple and projected earnings-per-share (EPS). A PE multiple shows how much a companys stock is trading for on the market compared to the companys actual earnings-per-share.
When a stock price is falling should you buy more? ›
If the price of a stock goes down, and you believe it has long-term value as an investment, then a lower price is a good opportunity to buy. The key is to choose quality long-term investments, by learning how to find quality companies to invest in or simply buying into an investment fund, such as an ETF or mutual fund.
Target costing, or target pricing strategy, is a pricing strategy that involves setting a price for a product or service based on the costs associated with making it and the desired profit margin. In target costing, all things are planned around a specific price point.
What is target pricing theory? ›
It is based on the costs of producing and delivering your product or service and what customers will pay for it. You first decide how much profit you need to make then set the price based on that. The set price meets two key requirements: It produces a reasonable profit for your business.
What is a price lining strategy? ›
Price lining is a marketing strategy that categorizes products or services based on their features and their overall value to customers. The aim of this strategy is to produce higher sales for a company by offering multiple pricing options for similar products.
What is the 11am rule in trading? ›
The 11 am rule in trading refers to a guideline followed by some traders, particularly day traders, which suggests avoiding making significant trading decisions or entering new positions during the first hour of the trading day (9:30 am to 10:30 am EST) and waiting until around 11 am EST to assess market direction and ...
What is the 3-5-7 rule in trading? ›
The 3-5-7 rule in trading is a risk management guideline that suggests limiting the amount of capital you put into any single trade. According to this rule, you should not risk more than 3% of your trading capital on any one trade, no more than 5% on any one sector, and no more than 7% on all trades combined.
What is the 10 am rule in stock trading? ›
Some traders follow something called the "10 a.m. rule." The stock market opens for trading at 9:30 a.m., and the time between 9:30 a.m. and 10 a.m. often has significant trading volume. Traders that follow the 10 a.m. rule think a stock's price trajectory is relatively set for the day by the end of that half-hour.
What is the key point in stock market? ›
The price of a stock changes based on the demand for shares from new investors who want to buy, or the supply of shares from existing investors who want to sell. Investors decide to buy or sell based on the company's performance, economic conditions, the current price of the shares, and other factors.
What are the two keys to successful investing in the stock market? ›
A long horizon and consistency are keys to healthy investment returns. I will start off by saying there's no magic bullet. The two things that separate successful investors from losers is 1) a long horizon and 2) consistency.
What is the best strategy for investing in stocks? ›
The buy and hold strategy is one of the most common and effective. It involves buying an individual stock and holding onto it for the foreseeable future. The idea is the value of the stock will grow steadily over time, and if you can resist selling it too early, you could hold a lot of value in the future.
What is the secret to investing in stocks? ›
Get the best possible price, even if it is a good stock. Pinch pennies on brokerage costs and reduce your opportunity cost to the bare minimum. Becoming an absolute penny pincher does a world of good to your investment success. Smart investors don't buy stocks, they buy the underlying businesses.
