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Simple Guidelines for Calculating Price Targets

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Investor-Update

An AAII member called last week asking for guidance on how to create price targets. Though very much a fair question to ask, it is not a question that’s very easy to answer. Do a search on Google for “how to determine a stock’s target price” and you’ll get 151,000 results. You have a better chance of correctly naming this year’s Final Four men’s college basketball teams than you do of choosing the search result that will routinely give you the best guidance for setting stock price targets. (For those of you who don’t follow men’s college basketball, there is more parity this season than I ever recall seeing.)

Target prices are simply forecasts. Like any forecast, they are frequently wrong. They are also subject to revision. Since the market and the economy constantly evolve, the data used to create a price target today will be outdated tomorrow.

More importantly, forecasts are dependent on the information fed into the model. Put bad data in and you’ll get bad data out. Even when the data comes from a reputable source, any assumptions used in the model will alter the outcome. This is a common problem with the discounted cash flow (DCF) models so often used by analysts. Seemingly small differences in the assumptions about future growth or interest rates can result in drastically different price targets. (DCF models use predictions of what a company’s cash flows will be between now and perpetuity, and then calculate how much those cash flows are worth to an investor today based on assumed rates of return.)

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The Week Ahead

Charles Rotblut, CFA, AAII Journal Editor, will speak to the AAII Orange County, CA chapter on Thursday and the San Diego chapter on Saturday.

Earnings season will stay near peak levels, with more mid- and small-cap companies reporting. Still, more than 60 members of the S&P 500 will release their results. Included in this group are Dow Jones industrial average components Coca-Cola (KO) and Walt Disney (DIS) on Tuesday and Cisco Systems (CSCO) on Wednesday.

The economic calendar is pretty light. The December Job Openings and Labor Turnover Survey (JOLTS) will be released on Tuesday. Friday will feature January retail sales, the University of Michigan’s preliminary February consumer sentiment survey results, January import and export prices and December business inventories.

Federal Reserve chair Janet Yellen will deliver her semi-annual monetary policy testimony to a House committee on Wednesday and to a Senate committee on Thursday. San Francisco president John Williams will speak in Los Angeles on Wednesday and Dallas president Rob Kaplan will speak in Dallas on Friday.

The Treasury Department will auction $24 billion of three-year notes on Tuesday, $23 billion of 10-year notes on Wednesday and $15 billion of 30-year bonds on Thursday.

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This month’s AAII Journal features our famed Guide to the Top Mutual Funds. The guide provides in-depth analysis of nearly 1,600 promising no-load and low-load funds. Plus, you’ll learn how to select the best funds for your own portfolio. If you Join AAII Today for only $29, you will get this widely acclaimed guide for free. Barron’s calls it “one of the best [guides] around on the subject.” Start your risk-free AAII membership today to get the Individual Investor’s Guide to the Top Mutual Funds 2016, and to benefit from everything else AAII has to offer.

 

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