Target practice – We prefer to rely on our own company analysis rather than that of brokers
Since dropping below 10p at the start of 2012, Dixons’ share price has rallied incredibly hard to the extent it now stands around 35p. So how would investors have fared if they had only relied on company brokers’ notes for guidance on whether to buy or sell? Not well, we would suggest, and for evidence we will consider the record of two such brokers, whom we will do the favour of keeping anonymous.
Broker X has for a long time had a strong conviction that Dixons is a ‘sell’. He had set his target price for the share at 13p and, for as long as the share price was in that region, he felt comfortable. However, the share price then started its upwards move and, despite his hitherto certainty the business was definitely and fundamentally worth no more than 13p a share, he began to have second thoughts.
To be fair, this is not unusual for brokers. The further their target price is from the actual share price, the more uncomfortable they feel and Broker X duly raised his target to the then actual share price of 30p – while still maintaining Dixons as a ‘sell’.
Some people might have lost confidence having previously called the value of the business wrong by a factor of some 200% but today, undeterred, Broker X is now purporting to be able to call the difference between Dixons’ current share price and its intrinsic value to within 20%.
Next under our microscope is, yes, Broker Y, who is actually one of the most respected practitioners covering the UK market. The chart below plots his target prices against the Dixons share price going back to 2005, when it traded above £1, and you may notice an interesting correlation between the two lines.
Source: Schroders and Bloomberg as at April 2013
At first glance you might think Broker Y is truly one of the best brokers in the world because he has apparently managed consistently to get his target price very close to the current share price. That, however, is not what this chart shows – in reality, the share price is leading the broker. Clearly it is preposterous to suggest the intrinsic value of Dixons has been bouncing around as much as the target price line would have it – it is just that, like his peers, Broker Y does not want to be too far away from the current share price.
What about Broker Y’s ‘buy’ and ‘sell’ recommendations? Once again, as you can see from the chart, there is an extraordinary correlation between the momentum of Dixons’ share price and the various calls. Thus, broadly speaking, when the share price is rising, Broker Y is recommending investors buy the stock and, when the price is falling, he is recommending they sell.
While that is not necessarily a bad thing in theory, the problem comes with the turning points – for example, it is all very well for a broker to keep increasing their target price and issuing ‘buy’ recommendations when the share price is rising but at some point things are going to flip completely and any investors following those calls are going to get hurt.
Once again, we would note Broker X and Broker Y are no different from their peers. This is simply a microcosm of what goes on in the market – a striking example of the herd mentality, of the psychology of investing and, most importantly, of the value of doing your own work rather than relying on other people.
It is for just this sort of reason that, here on The Value Perspective, we prefer to do our own company analysis and will not waste any time worrying about brokers’ recommendations and target prices. Rather than having our judgement clouded by share prices or the opinions of others, we have found independent thought much more profitable.
Fund Manager, Equity Value
I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.
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