What is target price and why is it so important for those who invest in the stock market? Guide on the meaning of the term, use and calculation.
If you are an investor, you will surely have come across the target price. What does it mean and why is it so important when talking about stocks, bonds or other assets to invest in?
Defined as the Target Price of a security and established by analysts or financial consultants, the target price represents the ideal goal identified to achieve the maximum return from an investment.
It is more simply a forecast resulting from analysis and reasoning on what the value of a certain security will be at the end of a considered period of time, usually a year.
The target price thus also becomes a point of reference for understanding whether the security is undervalued or overvalued compared to the indicated Target Price. The comparison between the real value of the moment and the indicated target price is therefore very useful for deciding whether to sell or buy the security in question.
For finance enthusiasts and investors, even beginners, knowing in detail what is the target price is therefore essential. Let’s see in detail why the Target Price is so important and how it is calculated through some practical examples.
Target price: what is it?
The target price, also known as fair value, represents the point at which a trader or investor decides to close their position, taking profit and maximizing the return on the investment.
In short, the target price is the realization of the best possible scenario for the investor.
According to the glossary, the target price is:
the price level that an investor usually intends to reach in a given time horizon when purchasing a stock
In essence, it is a price at which an analyst believes that a stock is fairly valued compared to its expected and historical earnings. When an analyst increases their price target for a stock, they typically expect the stock price to rise.
Conversely, lowering their price target could mean that the analyst expects the stock price to fall. Price targets are an organic factor in financial analysis: they can change over time as new information becomes available.
The target price is determined through financial analysis, which may include:
- Fundamental analysis (balance sheets, earnings, cash flows, industry);
- Technical analysis (price action, market trend, supports and resistances);
- Market multiples (P/E ratio, EV/EBITDA...)
It should be noted that the target price is a subjective estimate and may vary between different analysts. Different Target Prices may be formulated for each stock.
For example, for the Stellantis stock, which is currently worth just over 13 euros, HSBC analysts have set a target price of 11.5 euros while Goldman Sachs is positive on the stock and recommends Buy with a target price of 15 euros. For JP Morgan, the target price is even higher and set at 17 euros, with the suggestion to buy the stock, because it will appreciate.
How to calculate the target price
Defining the target price involves an evaluation of the company:
- according to the principles of fundamental analysis: the company that is analyzed from an administrative, accounting and financial perspective;
- with the help of technical analysis: the future performance of the stock is determined through supports and resistances, Fibonacci retracements and moving averages.
Target price in fundamental analysis
In the first case, the target price is a summary of the values reported in the balance sheet and defined through the discounted cash flows or through some specific balance sheet multiples (price/earnings, EV/EBITDA, etc.) that the analyst considers relevant for that specific asset.
For example, a common way to identify the price target for a stock is to create a price/earnings (P/E) multiple, multiplying the market price by the company’s last 12 months of earnings.
In some cases, especially with volatile stocks, analysts will look for additional guidance to formulate their target prices, which may include examining a company’s balance sheet and other financial statements and comparing them to historical results, the current economy and competitive environment, studying the health of a company’s management, and analyzing other ratios.
Target price in technical analysis
The technical analysis of the target price is based on the historical trend of prices and uses graphical and statistical indicators to predict the future value of a security.
Unlike fundamental analysis, it does not focus on company balance sheets, but on market data such as price, volume and trend.
For example, the target price can be identified based on resistance levels (areas where the price tends to stop or reverse).
If a security breaks a resistance with force, the target price is calculated by projecting the same distance between the support and the resistance.
Target price and impact on stocks, examples
The target price can have a significant impact on the price of a security, especially when it is updated by financial analysts from large investment banks or renowned institutions.
For example, if an analyst firm like Goldman Sachs or Morgan Stanley raises its price target, investors may view it as a bullish signal, increasing demand and pushing up the stock price. If the price target is reduced, investors may sell, fearing a future downturn.
If the price target is higher than the current price, many investors will see the stock as undervalued and start buying it. On the other hand, if the price target is lower than the market value, the stock may come under selling pressure.
A practical (but fictional) example:
Tesla stock is trading at $200
Goldman Sachs raises its price target to $250, expecting the company to grow. After the announcement, many investors start buying Tesla, believing in the upside potential. The stock quickly rises to $220 within a few days, thanks to increased demand.
Target price, why is it so important
The target price acts as a compass for the investor, a guide that allows you to formulate hypotheses on the performance of shares.
This indicator, proposed by experts, in fact affects the decisions to buy, sell or hold shares. Its relevance is closely linked to the precision of the forecasts, with recent studies attesting an average reliability of 60-70%.
Now, let’s talk about why the target price is so important, especially on the stock market. For example, let’s consider a share that is worth 60 dollars; if the company publishes negative results, experts can lower the target price from 70 to 50 dollars, triggering a massive sell-off and making the stock fall to 50 dollars. On the contrary, with positive results, the increase in the target price from 70 to 80 dollars can trigger a rush to buy, bringing the stock to 80 dollars.
Target prices require caution in interpretation, as valuations are influenced by many independent variables. In general, the target price, if correctly calculated, mainly highlights strong undervaluations or overvaluations.
In short, the target price plays an important role in the moves of the stock market. The discrepancy between the current price of the asset and the target price determines a trading strategy of buying or selling.
Original article published on Money.it Italy. Original title: Target Price, cos’è e perché è importante il Prezzo Obiettivo
