Are you new to stock investing? Among the many terms you have come across, target price is perhaps one of the most popular ones. To craft a successful investment strategy, you need to stay up to date with the latest market developments, including knowing the target prices of the stocks in your portfolio or on your watchlist.
Read on to find out what the target price for a stock means, how it is calculated, and what its purpose is.
What is the target price of a stock?
The target price of a stock is a predicted price level that analysts or investors think the stock will reach within a certain time frame. Here is what it means:
- If a stock is currently trading at £50 and an analyst sets a target price of £60, this suggests that the analyst believes the stock will go up to £60 in the future. As an investor, you could buy the stock now, wait until it reaches £60, sell it, and book profits.
- If a stock is currently trading at £50 and an analyst sets a target price of £40, you may want to consider selling it now (if you already own it), or short-selling it.
This price is often based on research, data, and analysis. However, it’s important to know that target prices are not guaranteed. The actual stock price can be influenced by many things, like market conditions or news about the company, that can cause it to go higher or lower than the target price.
In general, target prices are considered educated guesses or opinions. It can be helpful and it can inform your own decisions, but it’s important to do more research and consider your own financial objectives when making investment decisions.
How is the target price of a stock calculated?
There is no standard when it comes to calculating target prices. Different analysts or stock experts may have their own methods, hence the target price for the same stock may differ among experts.
Some of the main data used for determining the target price of a stock include:
- Company financials and ratios to determine the company’s financial health (the better the financial health, the higher the target price).
- Earnings estimates refer to calculating or projecting how much money the company is likely to make in the future (the more money, the higher the target price).
- Economic and industry conditions are also considered when estimating the target price. Target prices tend to be higher in economic booms compared to recessions (but this depends on the company and industry as well).
- Peer comparison is often used to determine how well a company performs compared to its competitors.
What is the purpose of a stock’s target price?
The purpose of a stock’s target price is to give investors, traders, and analysts an idea of where the stock’s price might go in the future. The target price serves as a reference point to help people make decisions about buying, holding, or selling a particular stock.
In other words, some investors use these target prices to determine the fair price of a stock. Some believe that stocks can be undervalued (the actual price is lower than what it is worth) or overvalued (the actual price is higher than what it is worth). Based on this, investors make decisions on whether to buy or sell them (for instance, buy undervalued stocks and sell overvalued stocks).
As mentioned, the target price is more of an educated opinion or guess, but you should not make investment decisions based on target prices alone. It is important to do your own research and consider more aspects that could influence the company’s future stock price, such as financial health, macroeconomic factors, and others, based on your own investment strategy.
Importance of stock analysis when determining the target price of a stock
It should be mentioned that many financial institutions periodically analyse listed companies to determine their target prices and whether they are undervalued or overvalued. It is important to note that, while these educated guesses may or may not materialise, target prices often influence investors’ perceptions and actions.
For example, let’s assume that Morgan Stanley revises a target price from £50 to £40. Investors sell the stock right away. Selling the stock will lead to a downfall in demand, which will impact the prices directly, causing them to drop lower.
This could have a significant impact on your portfolio if you own the stock as well. Hence, while target prices may not be sufficient by themselves to make investment decisions, it’s important to consider them in your strategy. For example, in this case, you may want to conduct your own research on the company and its relevance within your portfolio – as in, is the stock price decline a result of worsened financial health or is the stock price decline temporarily, for instance, due to a general decline in the stock markets?
If you are a long-term holder, you may want to keep the stock if the decline is simply due to the cyclicality of the stock markets as short-term volatility won’t impact you in the long term. However, if the target price declines because of the company’s increasing debt, decline in revenues, bad reputation, or other aspects that may threaten its long-term survival in the market, you may want to sell the stock.
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Stock target price: summary
Overall, if you own the stock, staying up to date with target prices could be crucial to knowing what to expect from the position in the near future. It could also inform buy and sell decisions, but make sure you do your own research as target prices may indicate the “fair value” of the stock, but they are not guaranteed.
Who sets the target price for a stock?
The target price for a stock is usually set by financial analysts who work for research firms, investment banks, or financial news outlets. Sometimes, independent analysts or investment advisors may also provide their own target prices.
How often is a stock’s target price updated?
The frequency of updates to a stock’s target price can vary. Some analysts update their target prices quarterly, in line with a company’s earnings reports, while others may update more or less frequently based on significant company news or market events.
What happens if a stock exceeds its target price?
If a stock exceeds its target price, analysts may revisit their analysis and potentially set a higher new target price. Investors who own the stock may also decide to reassess their own investment strategy—whether to sell and take profits or continue holding the stock in expectation of further growth.