3 Reasons to Come up With a Price Target

Hi, this is Cameron Hight from Alpha Theory.

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One of the most common questions I get is why should I come up with a price target. Isn't a price target just false precision?

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Well, there are three primary reasons why you should come up with a price target.

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One, it leads to better answers.

Two, price targets are predictive.

And three, it's a way to get feedback so you can improve.

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So, what do I mean by to get better answers?

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Well, imagine you're having a conversation with your analyst, and in that conversation, the analysts says I've got a lot of upside, some decent downside, but I'm pretty sure that the upside is going to go to our upside scenario. And you're trying to evaluate if that's the name you're going to put in the portfolio.

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Of course, they're going to give you more information than that.

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But, let's compare that to an analyst who comes in and says, I have an upside of 150. I have a downside of 50. I've got a 70% probability that it goes to 150, and there's a 20% expected return associated with the asset.

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And so, what that allows you to do is to ask very specific questions about how they came up with 150, how they came up with 50, how they came up with 70%.

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And all of those things lead to better answers.

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And those better answers are number two, the second reason why it's important to come up with a price target. Those price targets are predicted.

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What we found in our data is that we have over 1 million price target forecasts almost over the past 20 years from hundreds of firms and a thousand plus analysts. And what we see is that those price targets are predictive. They're not perfect, but they are generally better at predicting future returns and the position sizes the portfolio manager actually takes. So, making sure that you have them gives you better data to be able to better size positions in your portfolio.

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And the last reason is that we want to be able to measure ourselves. To be able to measure ourselves we need feedback. Those price targets and how we estimate them give us feedback that we can use to improve.

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Did the stock go to 15 like my analyst said? How close to 150? I can do that for every name they invest in. I can see what their biases are. And with that, I can be better as a portfolio manager.

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My analyst can be better.

We can do a better job of sizing positions in our portfolio and generating higher returns.