Today's Exciting Price Targets

I've long been interested in price targets -- what they do and don't tell us, and whether there's any use in them at all.

A brief overview of Wall Street analyst price targets
Price targets are purported to be the price at which an analyst believes a stock is likely to be trading in 12 months ... I guess. I'm not sure The Grand Council has ever issued a proclamation that strictly defines what a price target is, but that seems to be the most likely interpretation.

Let's look at a few large, high-profile companies and see what the Big Boys and Girls on Wall Street think the next 12 months portend for these stocks.

Wow. If these predictions come close to being true, investors have a sweet year ahead -- 22% 12-month returns, if events play out as predicted. Or as hoped for.

But, really, what do analysts rely on in making their estimates? There are, after all, an infinite number of ways to estimate a company's current value, and an even greater number (infinity plus one?) of ways to estimate what will happen in the future.

The price target is comprised of but two things: the analyst estimate of one-year forward earnings per share multiplied by a chosen price-to-earnings (P/E) multiple.

The estimates of year-forward earnings are, of course, notoriously inaccurate -- typically overly optimistic. A given earnings multiple, either for the market as a whole, a sector of the market, or a company specifically chosen, is for the most part a mere guess.

But we can learn something by looking at the consensus targets (read: guesses) for the stocks in the above chart. Revenues are all expected to grow -- and quite impressively, for the most part. Earnings estimates more or less track that revenue growth. But the price change estimates are expected to grow far faster than earnings growth.

In essence, the very impressive price target appreciation is highly dependent on an expansion of the multiple that investors are willing to pay for a dollar of earnings.

At least with these stocks.

Interesting, because P/E multiples aren't actually moving up
As I recently wrote, P/E multiples for the very largest stocks have been moving steadily down over the past decade-plus, to a point where they are now consistent with historical averages.

That might even make for a buying opportunity in large caps. However, keep in mind that these price targets assume that P/E multiples will significantly increase over the next year -- even for some companies with below average and slowing growth expectations.

Large-cap stocks receive the lion's share of attention, and usually the lion's share of optimism from analysts. Let's take a look at the three small caps we've recommended three times each in our Motley Fool Hidden Gems service, and what their price targets look like:

While analysts believe this group to be fairly priced, they nevertheless expect revenue and earnings growth to continue growing at an impressive clip. So a contraction in the P/E multiples is being expected here, along with the exceptional growth.

These three stocks have moved up in price recently (collectively they are up 207% since recommendation in our service), but on the basis of their continued impressive and consistent earnings and revenue growth (and exponentially greater market opportunities than most of the large caps listed above), they don't even need to maintain their current P/Es to provide solid returns over the next year.

Avoid price targets and focus on intrinsic value
Regardless, you should ignore the analyst community's price targets as a likely indicator of exceptional stock returns. Focus on the intrinsic value of the actual business itself, rather than gerrymandered data that yield only false precision.

That's what we focus on in Hidden Gems, and the results to date (54% returns for our recommendations vs. 19% for the market over the same time period) have us sticking to the strategy. You can learn more about it, and the 40-plus companies we're recommending by taking a no-risk 30-day trial. Today we released two new picks, so it's a good day to see what's new in our world.

Bill Barker does not own any of the stocks mentioned in this article. Microsoft, Intel, and Pfizer are Motley Fool Inside Value recommendations. Bank of America is an Income Investor pick. Disney is a Stock Advisor recommendation. The Motley Fool has a disclosure policy.