The Effect of Dispersion on the Informativeness of Analyst Target Prices

Management Science, forthcoming

55 Pages Posted: 21 Oct 2019 Last revised: 16 Jan 2024

See all articles by Asa Palley

Asa Palley

Indiana University - Kelley School of Business - Department of Operation & Decision Technologies

Thomas D. Steffen

Yale University School of Management

Frank Zhang

Yale School of Management

Date Written: January 11, 2024

Abstract

Consensus analyst target prices are widely available online at no cost to investors. In this paper we examine how the amount of dispersion in the individual target prices comprising the consensus affects the predictive association between the consensus target price and future returns. We find that returns implied by consensus target prices and realized future returns are positively correlated when dispersion is low, but they become highly negatively correlated when dispersion is high. Further analyses suggest that the differing effect of dispersion stems from incentive-driven staleness in price targets by some analysts after bad news. As a stock performs poorly and some analysts are slow to update their target prices, dispersion increases, and the consensus target price becomes too high. This has important implications for how consensus analyst target prices should inform investment decisions. We show that a hedge strategy taking a long (short) position in stocks with the highest predicted returns among stocks with the lowest (highest) dispersion earns more than 11% annually. Finally, we show that the negative correlation between consensus-based predicted returns and future realized returns for high-dispersion stocks exists mainly for stocks with high retail interest, suggesting that unsophisticated investors are misled by inflated target prices that are available freely online.

Keywords: analyst forecast, target price, stock return, dispersion, retail investors

JEL Classification: G11, G12, G14, G23, G41, M41

Suggested Citation

Palley, Asa and Steffen, Thomas D. and Zhang, Frank, The Effect of Dispersion on the Informativeness of Analyst Target Prices (January 11, 2024). Management Science, forthcoming, Available at SSRN: https://ssrn.com/abstract=3467800 or http://dx.doi.org/10.2139/ssrn.3467800

Asa Palley

Indiana University - Kelley School of Business - Department of Operation & Decision Technologies ( email )

Hodge Hall 4100
1275 E 10th St.
Bloomington, IN 47405
United States

Thomas D. Steffen (Contact Author)

Yale University School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Frank Zhang

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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