Portfolio Returns and Target Prices
36 Pages Posted: 6 Dec 2007 Last revised: 27 Jun 2008
In this paper we examine the profitability of trading strategies based on target prices embedded in equity research reports. We adopt target prices as information signals to build our portfolio strategy. At the first stage, we exploit implicit returns (difference between the current price and the target price) as a buying or short selling signal to open every transaction in the portfolio. Next, we use raw and adjusted target prices as a closing transaction signal. We build three different strategies to verify if the overshooting of target prices revealed by several studies could affect the profitability of a trading strategy based on these target prices.
We have formed four portfolios within every strategy to verify whether analysts' target prices have any investment value. We find that all strategies deliver positive abnormal returns against the market. In particular, the highest and lowest implicit return classes exhibit the highest stock returns and abnormal returns. In the last part control these returns for systematic risk, factors through the CAPM and the Fama & French three factor model. The positive performances of our strategies persist and, in particular, our strategies beat the market with consistent abnormal returns in all the four implicit return classes analyzed. From the three factors equation, it seems that analysts tend to advise buying stocks with risk above the average market risk, with growth profile and with large market value. Conversely analysts advise selling value stocks and those with a negative beta.
Keywords: Target Prices, Analyst recommendation, Portfolio strategy
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation