Understanding the Determinants of Analyst Target Price Forecasts
63 Pages Posted: 23 Mar 2014 Last revised: 18 Jul 2018
Date Written: July 4, 2018
We investigate the determinants of analysts’ target price forecasts and evaluate their relative importance in driving cross-sectional variation in target price implied returns. We identify four important determinants of target price forecasts: analyst private information concerning future prices, errors in forecasting fundamentals, misinterpretation of the return implications of firm risk characteristics, and biases related to analyst incentives. Our findings suggest that errors relating to forecasting earnings have a limited impact on the optimistic bias in target prices and that measures associated with analyst risk assessment are far more important. We also find that determinants reflecting analyst job-related incentives induce incremental optimism into target price forecasts. We use our determinants model to estimate the predictable errors in target price forecasts. We find that a trading strategy that goes long (short) in firms with low (high) predicted target price errors generates significantly positive abnormal returns over the following six months. Our results suggest that investors make similar valuation errors to analysts and/or do not perfectly back out the predictable target price bias when valuing firms.
Keywords: target price forecasts, financial analysts, forecast errors, market efficiency
JEL Classification: M40, M41, G14
Suggested Citation: Suggested Citation