A analyst price target is an analyst's estimated future price for a particular investment security. To arrive at a target price for a stock, the analyst may consider many factors, which are typically based on the outlook and projected earnings for that company.
Meaning of Target Price
Target Price is referred as the best possible projected price limit for a financial security. Target Price is a limit that is the best possible outcome for the stockholder's investment. Upon achieving the Target Price, the investors or traders simply sell their stocks, as according to them they have achieved the most probable reward from those particular stocks.
For example, two different stock traders hold the stocks of 600$. They may have different opinions about the financial profit that they can gain from these stocks. One trader could set his target price at 750 whereas the other trader could set the price at 1200$. Target Price Is subject to risk tolerance and the amount of time an investor trader can hold on to the security.
How to Set Price Targets on Your Stocks?
It’s important to set price targets on all your stocks the day you purchase them.
Your target should be based on the P/E of your stock, multiplied out by expected future earnings. I recommend that you at least think about what price your stock can achieve within 18-24 months. And that should at least be a 30%-50% gain. If it doesn’t have that potential, keep looking.
Going forward, when the stock hits your target, 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. Many analysts make this decision easy for you, by providing targets for their recommendations, and often cash in just a portion of the holding to take some profits and let the remaining half ride toward a new target.
When I speak at Money Shows across the country (pre-Covid at least), I am frequently asked about how I set my price targets. If it’s not the most common question I get, it’s certainly up there in the top five.
First of all, I can’t emphasize too strongly that it is essential to set a target at the time you buy a stock. If you don’t, then how the heck do you know when your stock has appreciated enough to sell it?
I always ask my workshop attendees how many set price targets on their stocks, and I never see more than two or three hands go up. That’s a shame, but I think it’s because folks just don’t know how to set targets, rather than them not wanting to. So, let me tell you how I do it, but keep in mind that, like all investing, it is not black and white. It’s a combination of science, art and experience. But most of all, it’s easy! No complicated math here just a few assumptions.
A Simple Way to Calculate the Target Price of a Stock
- The PE method tends to be more appropriate for growth-oriented stocks as EPS is expected to grow over time as a company becomes more profitable. A limitation of the PE method is that historic EPS values can be skewed for a specific year due to a one-off expense that results in a lower EPS for that year. Another limitation is that it does not provide a complete view of a company because it is only useful for equity investors. It does not give any consideration to the debt holders of a company.
- In understanding the basics of a key method of determining a stock’s target price, you are further setting yourself up for long-term financial success. After doing fundamental and technical analysis on a company, producing a target price helps to paint a clearer picture of the returns that can be expected. As stated earlier, solving for a target price is not a definitive solution. No one can predict the exact future price of a stock, but you can take the measures necessary to confirm if a company’s prospects are on the upside.
A target price is an estimate of a stock’s future price. You have probably seen various analysts giving target prices for companies such as Apple, Microsoft, and Amazon. There are many different models that analysts will use to produce a target price, with a discounted cash flow being one of the more popular models. The issue is that a discounted cash flow can get a little complex. Finding a target price does not need to be complex, which is why I will be showcasing to you a simple way to find the target price of a stock.
When it comes to producing a target price, you should first do your fundamental and technical analysis. Once you understand a stock regarding how its business is run and what kind of trends its price has been experiencing, you can then move into producing a target price.
It is important to know that calculating a target price is not a definitive solution to where a stock price will go. There are limitations to it, but in generating a target price, it adds more depth for yourself into the stock you plan on holding for the long-term. The simple way to calculate a target price is the Price-to-Earnings (PE) Method.
- PE is a measure of a company’s stock price relative to net income. The formula for PE is a company’s stock price at a specific point in time divided by its earnings per share (EPS) for a specific period. Earnings per share is a company’s net profit for a period divided by the number of common shares it has outstanding. So, how can we use PE to calculate target price? An example would be best to explain it.
Let us use Facebook as an example. On Yahoo Finance, navigate to its Financial page and make sure you are looking at its Annual Income Statement. Scroll down to finds its Basic EPS from 2016 to 2019. Since the values are in thousands, multiply each by 1,000 to get them in dollars per share. We find that Facebook’s EPS in 2016 was $3.60, $5.50 in 2017, $7.70 in 2018, and $6.50 in 2019. To get the year over year EPS growth rate, we will do the following formula: (EPS2-EPS1) / EPS1. The EPS growth rate from 2016 to 2017 would be: ($5.50-$3.60) / $3.60 = 0.528 or 52.8%. For 2017 to 2018, it is 0.4 or 40%. For 2018 to 2019, it is -0.156 or -15.6%.
Now that we have our EPS growth rates, we can find the average, which is 0.257 or 25.7%. Let us now solve the estimated EPS for 2020, 2021, and 2022 assuming it grows at 25.7% each year. The formula is EPS * (1+Average EPS Growth Rate) where EPS is the previous year’s EPS. For example, for 2020 we would do: $6.60 * (1+0.257) = $8.17. For 2021 it is $10.27, and for 2022 it is $12.91.
On Yahoo Finance, navigate to Facebook’s Statistics page. Here, look for the trailing PE as of December 31st, 2019. It is 32.89. The formula to calculate the target price is: (Price / Estimated EPS) = Trailing PE where Price is the variable we are solving for. For example, Facebook’s target price for 2020 is: Price / $8.17 = 32.89 where Price is equal to $268.71. Facebook was $205.25 at the end of 2019 and was $264.45 as of the market close on October 9th, 2020. That is not too bad of a target price for 2020. 2021’s target price is $337.78, and 2022’s target price is $424.61.
If you would like you to be more conservative with the target prices, you can multiply them by 0.9. What does that do? It considers a market correction. A market correction is defined as a period when a major index, such as the S&P 500, drop by 10% or more. So, in multiplying the target price by 0.9, Facebook’s 2020 target price is $241.84. In 2021 it is $304, and in 2022 it is $382.15.
Factors That Help to Determine a Price Target
The price target is based on assumptions about a security's future supply and demand, technical levels, and fundamentals. Different analysts and financial institutions use various valuation methods and take into account different economic conditions when deciding on a price target.
For fundamental analysts, a common way to discern the price target for a stock is to create a multiple of the price-to-earnings (P/E) ratio by multiplying the market price by the company’s trailing 12-month earnings.
In some cases, particularly with volatile stocks, analysts will look for additional guidance to form their price targets, which could include reviewing a company’s balance sheet and other financial statements and comparing them to historical results, current economics, and the competitive environment, studying the health of a company's management, and analyzing other ratios.
Technical analysts use indicators, price action, statistics, trends, and price momentum to gauge the future price of a security. One way that they arrive at a price target is to find areas of defined support and resistance. An analyst will do this by charting a price that moves between at least two similar highs and lows without breaking above or below those points at any point in between.