Understanding Target Prices: A Guide for Investors

Target prices are a tool that individual investors can use in order to make investment decisions. Being able to separate the good from the bad can go a long way towards your investment success. Target prices can be one of the most valuable indicators to an investor. Many investors make decisions based on ratings or recommendations by experts. While these ratings can provide a general opinion of what the experts think, they may not make sense for you. The expert does not know your individual situation, or whether or not when you bought into the stock in the first place. This makes target prices a more definitive recommendation for investors. Instead of relying on general statements, you can depend on clearly defined targets to shoot for.

Good vs Bad

When you are looking at the different target prices that are available on a particular stock, you need to try to determine if the prices are good or bad. Good target prices will typically come with a great deal of information that supports the reasoning behind the target price that was chosen. Bad target prices will not usually have any supporting evidence. They will be based on assumptions and the opinion of an expert. These types of target prices are no better than the ratings or opinions that are offered by the experts. 

EPS Forecast

One of the most important aspects of a target price is the EPS forecast. This stands for "earnings per share" forecast. This is a forecast of what is expected in the immediate future based on the earnings per share. Within this forecast, you should also be able to find a copy of the income statement and the operating cash flows. 

In order for an EPS forecast to be generated, the expert that is creating it has to make some assumptions. The quality of the assumptions is going to determine the quality of the forecast and the target price that is generated. You need to read the logic behind the assumptions and make sure that you agree with it. If the logic does not make sense, then there is a good chance that the target price is going to be off.

Multiples

The target price should also be based on valuation multiples. These are basic formulas that are used to determine the value of a stock. You want to make sure that the forecaster is using the correct type of multiple for the company. For example, the common standard for an industrial company is the price over earnings ratio.

Other types of companies might be more commonly analyzed by using the price over sales, or price overbook ratio. The expert will also have to use assumptions when using these multiples to determine the value. Research the logic of these assumptions to make sure that they make sense.