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Actual vs. Target Price in Stocks

Original post by Geri Terzo of Demand Media

The research analyst community is typically the group that assigns target prices to stocks. Price targets may differ from a stock's actual price, which is the market value representing where a stock is presently trading based on supply and demand. Analyst's might set short-term or long-term price targets, and could make these projections based on the belief that the actual stock price is undervalued or overvalued.

Identification

Equity analysts are in the business of performing research and assigning ratings to individual stocks and sectors. Analysts might also set a target price for a stock and may change that expectation in response to new research or company events. The actual stock price represents the current value that investors are assigning to that security. There is no guarantee that an actual stock price will attain the target price, although the latter is where an investment professional believes the stock will be fairly priced at a given time.

Influence

An analyst's price target could take effect immediately. If it's different than the actual price, it could send a message to investors that the stock is being wrongly valued. According to a 2011 article in "The Globe and Mail," analysts raised the price target on technology stock Apple after the company exceeded profit expectations. Investors responded to the profit surprise by rewarding the stock with a 3 percent gain. Analysts interpreted the results with more optimism and one firm, Brigantine Advisors, lifted its price target on the stock by 12 percent.

P/E Ratio

One way to determine a price target is to assign a price-to-earnings ratio. This equation includes dividing the actual stock price by the most recent earnings-per-share number to derive at a P/E ratio. A forward P/E is also needed, and this is a calculation using estimates for future earnings growth. The price target is established by dividing the P/E ratio by the forward P/E ratio, and multiplying the result by the actual stock price, according to the Zacks Investment Research website.

Consideration

Not all research firms believe in the effectiveness of setting price targets. According to an article on the Charles Schwab website, price targets are inconsistent and not usually right. One way to determine a price target is to consider future earnings performance, and the article suggests that because of unknown future events in the economy or at a company, forecasting is extremely difficult to do with any precision. Charles Schwab abides by a ratings system for stocks instead of establishing price targets.

                   

References

About the Author

Geri Terzo is a business writer with over 15 years experience reporting on Wall Street. Her coverage ranges from institutional investing, including hedge funds and investment banking, to family topics and her career experience includes work for Fox Business, CNBC and "IDD Magazine." Terzo is a graduate of Campbell University, where she earned a B.A. in mass communication.

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