Although highly subjective and often missing the mark, broker recommendations and price targets are important to track both before and after buying shares in a company. Here we make sense of the nuances in the different types of recommendations, as well as looking at how price targets are often calculated, and whether or not they can be trusted.
What are broker recommendations and price targets?
Broker recommendations and price targets are projections of a company’s share price performance across a given period of time. Typically updated following the most recent trading update or financial report, they provide an insight into the sentiment shared amongst industry professionals towards a particular company.
How are broker price targets calculated?
There are a number of different valuation methodologies used by brokers to determine a target price. As such, when considering the different valuations of a stock, it is important to identify the methodology used through accessing the reports created. However, even when using the same methodology, two firms can still produce very different findings, as the techniques deployed are often fairly subjective.
Putting that to one side, providing the company is already generating profit and cash, an analyst has the option of using an earnings or cash-flow basic metric to value the company. By using such a metric, the broker is then able to determine whether the company is trading at a discount or at a premium to the average of its sector. The most common technique deployed in this instance is the price-earnings (PE) ratio. Another technique is the enterprise value (EV), which can be used against a measure of earnings or cash generation to give a relative valuation.
Things become a lot less straightforward, however, when the company is loss-making or experiencing particularly strong growth – situations often seen amongst companies listed on the FTSE AIM Market. Under such circumstances, determining a price target becomes even more of an art than a science, with methods used including discounted cash-flow (DCF) or a relative valuation which compares a company’s value to that of its competitors.
What are broker recommendations?
Broker recommendations are related to but not the same as price targets. For instance, say that a stock that was trading at £2 per share had a 12-month price target of £3, then the company would most likely have a buy recommendation. Conversely, if the stock currently valued at £2 had a 12-month price prediction of £1, then it would follow that the company would most likely have a sell recommendation. Essentially, broker recommendations correlate to the price target but have a large number of other intricacies to them that can prove useful to understand – which we will discuss next.
What do the different broker recommendations mean?
Broadly speaking, broker recommendations can be divided into either buy, neutral or sell. However, within these categories, there are quite a few different labels that have important subtleties when making sense of the prevailing opinion of the broker. To make matters more complicated, brokers also tend to define their recommendations based upon different degrees of expected future performance, which can typically be found in the definitions section of the research notes.
Therefore, the definitions below are merely a generalisation and any specific recommendation from a broker needs to be investigated further.
- Strong Buy: This recommendation constitutes one of the broker’s best picks, with the stock expected to significantly outperform the market – typically by at least 20%.
- Buy: Another fairly strong conviction that the shares are inexpensive relative to its expected future performance. Appreciation of more than 10% is typically expected.
- Speculative Buy: This recommendation is characterised by high levels of risk but also the possibility of high levels of return providing certain business goals come to fruition.
- Outperform: Outperform indicates that the broker believes the company will perform better than its peers in the same sector or in relation to a given benchmark index.
- Top Pick: Stocks with this recommendation represent the best outperform rated companies in the outperform category. Expectations are high that the company will significantly outperform its sector.
- Sector Performer: Returns are expected to be in line with the sector average.
- Moderate Buy: This is a fairly descriptive term, suggesting a certain amount of caution should be applied if deciding to buy the shares.
- Accumulate: Another descriptive term, this suggests that the shares should be added to within certain parameters. For instance, it might be that the stock is only worth buying under a certain price point.
- Overweight: This is an interesting term that avers that the weight of the shares in question should be greater than the weight of the shares in a given index or coverage universe used for comparison. To depict this, say, for example, Barclays represented 5% of the FTSE 100 but constituted 7% of your portfolio, then you would be overweight in Barclays’ shares.
- Add: Similar to moderate buy in the sense that caution should be taken if adding to a particular holding.
- Hold: Pretty self-explanatory – the investor should refrain from taking action in the near-term and wait for further developments to take place.
- Neutral: This recommendation generally means that the broker anticipates that the stock will perform at or near the current share price and generally in-line with the market.
- In-line: Similar to neutral, the analyst expects the stock to perform approximately in-line with the market or the coverage universe used for comparison.
- Equal-weight: This is based on the same logic used for overweight, meaning that the investor should hold the shares in proportion to its weight in the index.
- Underperform: A recommendation of underperform would indicate that the broker believes the stock is fully-valued or overvalued at current levels, and it is projected to perform worse compared to the market or coverage universe used for analysis.
- Moderate Sell: Another descriptive term that suggests that the broker views the company’s current share price as high relative to its peers or financial forecasts.
- Weak Hold: A recommendation of weak hold would indicate that the broker is waiting on further developments but possibly changing their view on the company from a hold to a sell position.
- Underweight: Again, this is based on the same logic used for overweight, meaning that the investor’s holdings in the company in relation to its full portfolio should consist of a percentage below the percentage proportion that the company constitutes in terms of its overall index.
- Reduce: The shares of the company with this recommendation have more downside risk than upside, and therefore investors should reduce their position until its valuation or fundamentals become more compelling.
- Sell: As you would expect, this recommendation constitutes a warning that the stock is currently overvalued and that investors should expect a depreciation in share price – typically in the region of 20%.
- Strong Sell: As the strongest warning, a strong sell recommendation would be a clear indicator that the broker believes the fundamentals of the company and/or industry to be precarious and highly likely to deteriorate in the near-future.
- Corporate: A corporate rating is issued when the company is a corporate client of the brokers.
Can you trust broker recommendations and target prices?
As already referenced, broker ratings and price targets are highly subjective. By tweaking some of the parameters and assumptions made, the end result can be altered quite considerably. As a result, these predictions have varying degrees of success.
Nevertheless, they remain to be one of the most important sources of information when following the sentiment shared amongst industry professionals towards a particular company. Therefore, they should serve as one of your main starting points for determining whether or not the company is trading at a premium or at a discount. They should not, however, be your only source of opinion.
To track the latest aggregated broker recommendations for UK markets head on over to Shareview from Equiniti.
*Many thanks to George Stainton for his excellent article on Broker Recommendations written whilst at CSS Investments. The information provided was a main point of reference whilst putting together this article.