What Drives Target Price Forecasts and Their Investment Value?

Abstract

This paper examines the informativeness of analysts' target price forecasts by relating the investment value of target prices to their primary drivers. Decomposing target price forecasts into near-term earnings forecasts and price-to-earnings ratio forecasts, we show that target price revisions reflect information from both components. In addition, we also find that the relative importance of each component in target price revisions is related to firm characteristics. A portfolio based on target price implied expected returns delivers significant abnormal returns. More importantly, we find that the abnormal returns are associated with both earnings and price-to-earnings forecasts, which suggests that the informativeness of target price forecasts comes not only from analysts' ability to forecast short-term earnings but also from their ability to assess risk and long-term growth prospect implied in price-to-earnings forecasts.