Target Price Accuracy

Headnote

Abstract

This study analyzes the accuracy of forecasted target prices within analysts' reports. We compute a measure for target price forecast accuracy that evaluates the ability of analysts to exactly forecast the ex-ante (unknown) 12-month stock price. Furthermore, we determine factors that explain this accuracy. Target price accuracy is negatively related to analyst-specific optimism and stock-specific risk (measured by volatility and price-to-book ratio). However, target price accuracy is positively related to the level of detail of each report, company size and the reputation of the investment bank. The potential conflicts of interests between an analyst and a covered company do not bias forecast accuracy.

Keywords: target prices, forecast accuracy, financial report, security analysis, efficient capital markets, financial analysts, conflicts of interest, analyst report, equity analysis, forecast deviation, information content

Manuscript received June 21, 2010, accepted by Christian Schlag (Finance) January 19, 2011.

1 Introduction

Analysts' reports play a decisive role in capital markets. Along with company releases, reports issued by financial analysts provide information for all kinds of different market participants such as fund managers, pension managers, or high-wealth investors. Consequently, economic research has focused on analyzing whether capital markets react to analysts' reports. Various studies have found that market participants appreciate the information derived by analysts. However, traditional studies (e.g., Abdel- Khalik and Ajinkya 1982, Elton, Gruber, and Grossmann 1986, Lys and Sohn 1990, Stickel 1991, Stickel 1995, Womack 1996, Mikhail, Walther, and Willis 1997) have focused exclusively on the market impact of recommendations (e.g., levels like buy, hold and sell recommendations or their revisions) and earnings forecasts which analysts disclose in their reports.

The literature only recently shifted its focus towards a third quantitative measure: target prices. This is due to the fact that major databases like First Call from Thomson Financial initiated coverage of target prices only at the end of 1996. Hence, 1997 is the first complete year where standard data providers delivered data concerning this measure. This information is taken from Brav and Lehavy (2003). Other studies from Asquith, Mikhail, and Au (2005), Gleason, Johnson, and Li (2008), and Bradshaw and Brown (2006) similarly showed that target price availability started in 1997. Nevertheless, via target prices (in relation to current stock prices) analysts can disclose more detailed information...