Rudi's View | Jun 25 2020
Dear time-poor investor: stockbroker price targets can be a handy tool for investors, when treated with intelligence and experience
–Price Targets Can Be Your Friend
-BHP, CSL And CBA Versus Telstra
Price Targets Can Be Your Friend
By Rudi Filapek-Vandyck, Editor FNArena
I haven’t written about stockbroker price targets and consensus targets for a while, plus I received a number of questions about them recently. Time for an update.
Let’s assume I like a certain company and I would like to buy its shares and add to my investment portfolio.
I might have an idea about what this company does, and how it’s positioned in an overall groovy looking industry.
There is a past record to pay attention to, and forecasts are available too. I might even look at a price chart to see how the share price has performed and how volatile it is.
But how much do I think the shares are worth?
It’s an intriguing question and one that can potentially elicit endless discussions about Ben Graham’s base principles and how much of an influence low inflation and bond yields near historical lows exert on a company’s valuation in modern times.
There is also the added observation that an extremely low valuation is seldom an indication of a low risk, sustainable longer-term investment while an above-average Price-Earnings (PE) ratio is not necessarily a harbinger of a share price crash that hasn’t yet happened.
In reality, many of the stocks trading on higher PE ratios have proven a much better investment than peers on low PEs, and this has been going on for many years now.
So why don’t I leave this to the experts who are paid to follow and analyse stocks as a full-time occupation?
Most stockbroking analysts these days are kind enough to not only calculate a valuation based on their modeling assumptions and forecasts; in most cases they provide a price target too – it’s where they think the share price should be in 6-12 months’ time, all else remaining equal.
Those four words at the end of that previous sentence give away the first and foremost mistake many investors make when focusing on stockbrokers’ price targets. Theirs is not a static process, such as determining the distance between Brisbane and Melbourne.
In the share market, as well as in the real world (i.e. the day-to-day economy), circumstances and context remain seldom the same for very long. This clashes with our human desire to receive guidance that is set in stone, irrespective of what happens.
It’s the same error investors make when basing decisions on PE ratios. Years ago, it was pointed out to me High PE stocks such as REA Group ((REA)) and Seek ((SEK)) usually saw their shares weaken around May-June each year.
Because that’s when PE ratios elevate beyond historical averages. That is, if we continue to focus on the financial year that is about to end and which will be reported in August.
The crucial error investors selling out were making is that professional investors by now are already looking forward to FY21 and FY22.
Sure, we don’t know yet what the exact numbers in August might look like, but if these growth companies continue to grow year after year, then this year’s PE ratio has to look high by the time the calendar shows May-June.
It’s either that or something’s wrong with how fast these companies are growing.
Lesson number one is thus: financial indicators, whether they be targets or forecasts or a multiple derived from forecasts should never be treated as an inflexible, stand-alone, set-in-stone, never-to-change indicator.
Always keep in mind things can, and will, change.
This in particular applies for sectors and stocks that are impacted by many moving inputs, like commodity producers.
Another complication is that when multiple experts look at the same company, they often end up drawing different conclusions.
UBS doesn’t like Afterpay ((APT)). The broker currently has a price target of $14. At Ord Minnett the price target was recently raised to $64.70.
No guessing why UBS has a Sell rating on the stock, and Ord Minnett has a Buy.
Most analysts covering Afterpay have a price target closer to Ord Minnett’s, but most are below today’s share price.
So what’s the ordinary investor to do with so much conflicting inputs?
Enter consensus price targets. Many years ago, I discovered consensus price targets, essentially the average of multiple targets published by stockbrokers covering the same company, can be used as a handy tool for assessing entry and exit decisions.
As a rough, plain vanilla concept, my interest is usually awoken when a share price weakens more than -10% below its consensus target.
Every time I try to establish what is likely the cause of this gap opening up. There is a big difference between market momentum switching out of, say, Coles ((COL)) and Woolworths ((WOW)) as a result of portfolio rotation by institutions into banks and commodity stocks and, say, Speedcast International issuing yet another profit warning, which forces management to renegotiate the company’s survival with its lenders.
When things change, one has to remain flexible enough to accept that things have really changed, and not necessarily for the better.
In another scenario, when companies are on a winning streak, and operational momentum is so strong that it creates a string of positive upgrades -as has been the case with Afterpay this year- we should equally acknowledge that broker updates (with upgrades) happen at a delay, and the share price is not sticking around to see what the next upgraded target might look like.
Broker targets are most reliable for companies and circumstances that are relatively steady.
We can all multiply the price of iron ore by projected volume minus costs, but not if AUD/USD swings around or when the price differential between high grade and lower grade opens up, and that’s not even mentioning the price of iron ore itself, plus freight charges.
Some sectors are more stable than others most of times.
Banks in Australia used to be pretty straightforward, with relatively low unpredictability, but this too has changed since a few years.
Nevertheless, if anyone cares to check share prices of ANZ bank ((ANZ)), National Australia Bank ((NAB)) and Westpac ((WBC)) via Stock Analysis on the website, you’ll find bank share prices are still among the most faithful in the market when it comes to consensus targets.
Their share price seldom remains above target for long. The exception is, of course, CommBank ((CBA)). CommBank shares are the complete opposite.
Being the premium brand in the sector domestically, CBA shares always trade at a premium versus the rest. This sees the stock trade seldom below consensus target, and most of times above it.
Thus, when it comes to the consensus target, CBA shares should be judged differently. The same applies to Cochlear ((COH)), for example.
Making forecasts and modeling assumptions in the current market context comes with above average uncertainty for a guesstimated three quarters of ASX-listed companies.
What exactly will 2021 look like? We don’t even know who’ll win the US presidential election in November, or whether that dreadful second wave could ultimately dwarf the impact of the first one, or when Australia will open up its borders.
This variety in potential outcomes and scenarios is currently also reflected in a wider-than-usual gap in between forecasts and price targets for companies that are operating under extreme uncertainty.
Take Flight Centre ((FLT)), for example. UBS, being the high marker, has set a price target of $16.60. The low marker, Ord Minnett, refuses to go higher than $8.96.
The share price, believe it or not, has mostly traded in line with consensus, which is currently at $13.13.
Many investors find it a challenge to cope with such extreme non-conformities, it’s too confusing. Years of market observation have taught me there is value in having outliers and opposing views. They show us, investors, what risk possibly looks like, in both directions.
My personal recommendation is to do your own research, form your own view, and if it is positive take guidance from the positive views. Keep paying attention to the others. If your view is negative, do things the other way around.
I still hold a positive view for CSL ((CSL)) shares, while acknowledging short-term risks have risen somewhat because of the stronger AUD and a potential dip in plasma collection. But the share price is only a smidgen above the low marker’s price target, at $288, and Morgan Stanley has made it clear it doesn’t want to overpay.
In that same healthcare sector, ResMed ((RMD)) has a larger number of detractors, but thus far taking guidance from the experts with a positive view has proven the most beneficial approach.
The most confounding aspect of paying attention to stockbroker valuations and price targets is that the gap between target and share price can sometimes blow out to ginormous proportion.
This does not automatically imply here lays a bargain ready to be jumped upon.
FNArena’s Icarus Signal includes an overview of the 50 stocks whose share price is trading the furthest from consensus target.
Investors new to this might be surprised to read the target for New Century Resources ((NCZ)) -loss-making zinc and lead- is currently trading some -177% below Credit Suisse’s price target of 50c.
Ok, first up, Credit Suisse is the only broker in the FNArena universe that covers this stock. There is no consensus target as such.
Secondly, the company is engaged in negotiations with Vale for the potential purchase of the Goro nickel & cobalt mine in New Caledonia.
If an agreement can be reached, and that remains a big if, the details of the deal, and how it will be paid for, are crucial to the future of the share price.
This, I believe, is exemplary of why stocks such as New Century Resources trade at such a large gap to where the price potentially can be: lots of risk and uncertainties, and a lack of investors prepared to take it on.
For some market participants there is always the lure of what if? What if things do turn around positively?
MMA Offshore ((MRM)) shares are trading -157% below Morgan Stanley’s price target of 18c. For shares in Cardno ((CDD)) the implied gap is -168%. For Cassini Resources ((CZI)) -nickel and copper, in JV with OZ Minerals ((OZL)), the gap is -87%.
Investors should always be mindful that valuations and price targets can move in both directions. In case of adverse development, they can equally come down like a feather tied to a giant rock.
Broker forecasts and valuations/price targets can be an extra tool in support of portfolio construction and investment strategies, but they are not infallible, let alone the be all and end all for fundamentally oriented investors.
At times these targets are there to strengthen confidence, to show direction or to reveal market sentiment, but they can just as well be completely off the mark.
It’s the work of humans after all, and companies are organic creatures, not simply a mathematical model in an excel spread sheet.
As the founder/Editor of FNArena I am regularly asked what is the accuracy of all those broker recommendations? Years ago, I did some research into this topic and concluded it’s probably around 6/10.
Even then, it still very much depends on what the general trends and context are, and whether the broad trajectory is straight, or whether we see multiple changes and interruptions in between.
When using price targets set by stockbroking analysts, investors should apply the same principles.
It’s easier to predict the future when the road is wide and straight, plus market sentiment does not always follow the logic behind a valuation based on fundamentals.
I speak from personal experience when I say that using price targets, and consensus targets in particular (with added market intelligence), can add that extra insight that sometimes comes in handy.
As with every other tool and market indicator; nothing is flawless, nothing is perfect. Personal insights and experience are essential.
BHP, CSL And CBA Versus Telstra
I think I can safely claim my research from the past has inspired a recent comparison made between the differences in investment returns for shares in BHP Group ((BHP)), CSL, CommBank and Telstra ((TLS)).
I think you all know the answer which stock has performed best over the past twenty years or so, and which one the worst.
Here’s the story:
My audio interview from last week:
(This story was written on Monday 22nd June, 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: firstname.lastname@example.org or via the direct messaging system on the website).
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