Target Price Forecasts: Fundamentals and Behavioral Factors

Abstract:     
This paper shows that both fundamental and behavioral factors play an important role in analysts’ target price formation. Specifically, analysts’ forecasts of short-term earnings and long-term growth are shown to be important explanatory variables for analysts’ target prices. However, the following behavioral factors that are salient but irrelevant to fundamental value are also shown to explain target price levels and especially target price biases: the past 52-week high price, lagged investor sentiment, and rounding. Increases in the 52-week high and investor sentiment of one standard deviation correspond to increases in the target price bias of 4.7% and 14.7%, respectively, while rounding of the target price corresponds to an increase in the target price bias of 13.6%. We also find that there is a significant spike and absolute maximum in the target price distribution exactly at the 52-week high price. Additionally, our results show that analysts’ target prices are useful in predicting future stock returns beyond earnings forecasts and commonly used risk proxies, but only when the 52-week high price is close to the current stock price and investor sentiment is relatively neutral. We find our results are robust to the inclusion of a lagged target price measure designed to capture unobserved analysts’ incentives and characteristics. Additionally, we find that analysts place greater weight on the behavioral factors in settings with greater task complexity and/or resource constraints.

Number of Pages in PDF File: 50

Keywords: analysts, target prices, 52-week high, investor sentiment, rounding, earnings forecasts, long-term growth, return predictability

JEL Classification: D81, D82, G12, G14, G29, M41

working papers series