Do Analysts’ Target Prices Stabilize the Stock Market?

Abstract

If target prices reflect the true values of stocks, they should direct prices towards intrinsic values. But analysts’ optimism and use of less sophisticated valuation methods have been found to impede target price informativeness. We find that target price optimism has a positive effect on the informativeness of target prices by driving target prices closer to intrinsic values, but only when investor sentiment is low. When sentiment is high, however, we find that target price optimism drives target prices away from intrinsic values. Overall, we find target price informativeness is highest when sentiment is low and target prices are inferred to be based on sophisticated valuation methods. With high sentiment, irrespective of the implied valuation method, we find that target price informativeness approaches zero (such that target prices have low investment value), but investors’ reactions to target price revisions are strongly positive and seemingly irrational - which potentially destabilizes markets.