One aspect of my character that has served me well over the years is a healthy sense of skepticism of what I hear or read. This “skill,” for lack of a better word, is becoming increasingly important in the information age, more accurately described as the misinformation age. I read a lot to know what the current market sentiment is, but take it all with large grains of salt. I had always been skeptical about the value of financial analysts’ target prices. However, I never had proof to validate this gut feeling and proof is important to me, as it should be to everyone.
In early December 2022, the Globe and Mail published an article with analyst ratings and target prices for all 232 stocks listed on the TSX, Canada’s main benchmark. I printed the article and made a note to myself to evaluate a year later. How accurate were the predictions? This is the first time I had seen such a comprehensive list of projections, presenting an opportunity to either validate or invalidate my gut feeling.
I started the project looking up the current price of all companies listed. I then averaged the early December 2022 price of each company categorized by the 10 commonly used sectors. I then averaged analyst target prices for each company in the sector, and then the early December 2023 price.
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I soon realized using an average of all companies wasn’t the best way to evaluate. Instances where analysts were way wrong on the optimistic side were offset by projections that were way wrong on the pessimistic side. I asked myself: “Self, I wonder how the stocks with the top three most optimistic projections compare with the bottom three most pessimistic projections?” Therein came the real story.
Please look first at the technology sector to best demonstrate how the wrong optimistic views could offset wrong pessimistic views. The all-company averages show analysts expected an average gain of 24.6 per cent and the stocks experienced a gain of 26.2 per cent. Pretty darn close!
However, the highest three rated companies had an average expected gain of 80.3 per cent but ended down 12.5 per cent, whereas the lowest three companies were only expected to gain 7.5 per cent but appreciated 31.4 per cent. The lowest-ranked companies dramatically outperformed the highest-ranked companies.
Was the technology sector an anomaly? In short: nope. I highlighted in green whether the top or bottom three companies outperformed, and in half the sectors the very-bottom-ranked companies outperformed the very-top-ranked companies. Even where the top three outperformed, there was often a huge gap between expectations and results. For example, the top three financial companies were expected to gain 70.3 per cent, while only gaining 15.3. The bottom three were expected to gain a modest 3.6 per cent and were up almost the same as the top three. Those are big misses.
This paragraph might bore you, so please feel free to skip it, but for technical accuracy I wanted to clarify something. Companies with higher dollar share prices have a larger influence on the averages than those with smaller dollar share prices. This is why I adjusted the two companies with share prices of over $1,000. Luckily, neither were in the top nor bottom three, but they would have had a distorting influence in the all-company analysis. After adjusting, they still had an outsized influence, but no more so than other companies with $200 share prices.
It is important to be mindful that this is only one year of information. Also, the target prices were an average of all analysts covering a stock and, as in all professions, there can be a wide variation in skill level. Finally, it would have been more accurate to do the entire analysis in percentage terms, but that would have required another day of number-crunching, and I can confidently say it wouldn’t have had a meaningful impact on the overall picture. The results are simply that stark, and even surprised the skeptic in me.
I will continue to ignore analyst target prices in my purchase or sale decisions.
