Think Before You Buy a Stock Based on Analysts’ Price Targets

Sometimes a historical moment is captured in a turn of phrase, as France on the brink of revolution was defined by Marie Antoinette’s “Let them eat cake.”

The cementing of the Internet as a force in the stock market may have been captured in a number: analyst Henry Blodget’s now-famous $400 stock price target for Amazon.com.

When Blodget, then an analyst for brokerage CIBC Oppenheimer, made that call in December 1998--essentially predicting that the online bookseller’s shares would more than double within a year, after an already spectacular surge by that point--he was saying as much about the future of the Internet overall as he was about that particular stock.

The call also garnered massive publicity for Blodget--and in the process, focused investors on what has since become a much bigger game across Wall Street: Analysts no longer just set earnings estimates for companies; many also now name a specific, and sometimes seemingly outrageous, target price that they expect a company’s stock to reach, generally within 12 months.

The practice is supposed to be rooted in fundamental analysis--i.e., a company’s earnings outlook--but it also has become controversial, in part because a hot analyst covering a hot stock can mean a price target can quickly become a self-fulfilling prophecy.

That was an issue with Blodget’s call on Amazon.com: Some investors immediately took his opinion to heart, sending the stock up $46 the day the target was set. Within just 14 trading days, the price (before two subsequent stock splits) surpassed the $400 target Blodget had expected could take as long as a year to reach.

It was a powerful demonstration of the way that raw opinion--though informed opinion, to be sure--can feed back through the market at warp speed and be transformed into a huge price move.

Blodget, as it turned out, wasn’t optimistic enough. Amazon continued to rocket early in ‘99, though the shares have since retrenched.

The practice of aggressive price targeting has become widespread among analysts over the last year, and some individual investors have come to view such targets not as estimates but as virtual certainties for the stocks involved.

But investors ought to approach any target price with skepticism, many money managers say.

“Price targets generated by Wall Street analysts may be trying to serve multiple masters,” warns James Weiss, investment chief at State Street Research in Boston.

Although brokerage stock research is supposed to be an entirely separate function from the firm’s investment banking business, it’s accepted that an analyst’s tout of a particular stock can only help in the brokerage’s efforts to land lucrative stock-underwriting assignments or other investment banking business.

Of course, no reputable analyst would make a positive call on a company he or she feels negatively about, Weiss said. Nonetheless, an analyst who feels very bullish about a stock “may lay on another 30 points [to a price target] just to say to the company, ‘We’re a big supporter.’ If you can communicate what you believe and do it in a way that generates publicity and endears you to the company, why not?” Weiss said.

Brokerages, and analysts, insist that their price targets can’t be influenced by anything other than the fundamentals. “We have a responsibility to 8 million clients to be realistic,” said Andrew Melnick, co-director of global research at Merrill Lynch, which hired Blodget shortly after his Amazon call.

Price targeting for individual stocks may be viewed as the natural outgrowth of Wall Street’s obsession with quarterly earnings forecasting, experts say. Many investors, after all, want details to be as specific as possible as they weigh stock buy and sell decisions.

While Melnick concedes that a long-term investor may well wonder why he or she should care about a 12-month price target, “If you’re a trader, price targets are critical,” he said.

The idea being: If a stock gets temporarily ahead of a “fair” price, a short-term trader may want to exit rather than ride through a potential pullback.

In fact, Merrill Lynch requires a 12-month price target on any stock for which an analyst has issued an “intermediate buy” recommendation, Melnick said.

And how, exactly, do analysts arrive at price targets?

Setting a target often begins with an analyst’s estimates for earnings over the next 12 months. But it isn’t necessarily a simple arithmetical exercise, analysts say.

For example, shares of firms in the same industry may be priced at different multiples of their per-share earnings, depending on whether they are dominant players or also-rans, and depending on whether the earnings guidance that they provide to analysts has been reliable in the past.

The result is that the range of year-ahead share-price targets tends to be wider than the range of earnings estimates for many firms.

Take Intel, for example. Analysts surveyed within the last 30 days provided 12-month targets ranging from $84 to $150 for the computer chip giant. But with last week’s surge, Intel reached $103.06 by Friday, when it reported stronger-than-expected quarterly earnings.

Some Intel analysts now will have to reconsider their price targets. But will they do so because, as many will argue, the fundamentals have changed for the better--or simply because the stock is on a tear and an analyst is fearful of leaving the party too early?

In following the market higher with their targets, some analysts may be relying less on solid fundamentals than on their own guesses about how wild the bidding environment for a stock may become.

“I’m not sure that some analysts even fully understand what they’re saying” with a price target, said Charles Hill, research chief at First Call, which tracks earnings estimates and, for the last year, price targets issued by analysts.

“Let’s say one month ago you had a $100 target on a stock for the next 12 months,” Hill said. “Now you come back a month later and reaffirm your $100 target for 12 months. In a sense, you’re lowering your target,” he said, because you’re tacking an extra month on to the original “deadline” for the stock to reach your target.

Price targeting for Internet stocks can, of course, be an even more complicated game. With many Net stocks, “there’s no basis for valuation,” noted Ralph Wanger, manager of the Acorn Fund in Chicago. “There’s no positive cash flow, no earnings per share--you could sell any damn number,” he said of analysts’ price targets.

Analysts who set price targets on Net stocks say they typically look at a company’s “franchise” value and its expected sales growth in determining where the stock should fairly trade in the coming year.

Merrill’s Melnick acknowledged that in developing industries such as the Internet and, perhaps, human genomics, stock price targets may be more useful as broad indicators rather than as specific buy-sell benchmarks for a stock.

“Even though it sounds like an extreme price target,” he said, “if the industry achieves the kind of potential it should achieve, this is what could happen to a company with a dominant position.”

Walter Piecyk, telecommunications analyst for brokerage Paine Webber Group, said he used a similar rationale when he recently assigned a price target of $1,000--now a split-adjusted $250--for fast-growing wireless firm Qualcomm.

Piecyk’s price target, which was widely reported, in effect told investors that he thought Qualcomm’s shares would double in 12 months. As in the case of Amazon.com, Qualcomm had already been an extremely hot stock. Yet the shares rocketed again on news of Piecyk’s target, surging 31% in a day. The price has since slid from a record high of $200 in early January to $140.44 now.

“Wireless companies tend to have negative cash flow and negative earnings” now, Piecyk said. “What are we really investing in? Future cash flow.”

When he gave the Qualcomm target, Piecyk said, he was “not looking at a multiple of 2001 or 2000 earnings, but what the royalty stream of their technology would be worth over the next 10 years.”

He added that it would be hard to find an analyst who has “over-forecasted where the wireless industry was going to be.”

Still, as many analysts appear to one-up one another in the price-targeting game, some Wall Street pros wonder if the end result will be far too optimistic analysts, far overpriced stocks and, ultimately, many unhappy investors if the market should enter a sustained slide.

The Acorn Fund’s Wanger joked that there is precedent for treating Blodget’s famous $400 Amazon call as a metaphor--and perhaps an ominous one--rather than taking it literally. In the Bible, he noted, the number 400 is sometimes used to signify a vast quantity.

“Four hundred was kind of Hebrew for a gazillion,” Wanger said.

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Wall Street’s Price Targets: A Game of ‘Can You Top This?

Wall Street analysts are under increasing pressure to put price targets on the stocks they follow. That usually means a price the analyst believes a particular stock can or should hit in the coming 12 months. When a stock is hot, price targets can egg it on, as analysts rush to be first with a higher-yet target price. Here’s how shares of Motorola have fared since October, and how various brokerages boosted their price targets during the run-up.

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Sources: Bloomberg News, Times research

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In the Bull’s Eye?

Wall Street analysts increasingly are issuing “price targets” for stocks they follow. Usually those are prices they expect particular stocks to reach within 12 months. As the data here show, the range of target prices can be very wide. Shown here for each of five major stocks is the number of analysts who have recently updated their price targets. (Other analysts may have target prices as well, but haven’t updated them recently.) In the case of Intel, last week’s surge in the price has already pushed it past many analysts’ 12-month targets.

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Times staff writer Thomas S. Mulligan can be reached by e-mail at thomas.mulligan@latimes.com.