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R2 5.9% 6.7%
p-values of tests of equality of coe„cients
Z1 ¼ Z2 0.072
Z3 ¼ Z 4 0.000
Z1 ¼ Z3 0.000
Z2 ¼ Z 4 0.794
An Empirical Analysis of Analysts™ Target Prices 1963

V. Summary and Conclusions

Using a large database of analyst price targets, stock recommendations, and
earnings forecasts, we examine short-term market reactions to target price an-
nouncements and long-term comovement of target and market prices. Consistent
with our predictions, we ¢nd that target prices are informative both uncondition-
ally and conditional on contemporaneously issued recommendation and earn-
ings forecast revisions. Moreover, revisions in target prices contain information
about six-month postevent abnormal returns. Recommendation and earnings
forecast revisions are also found to be informative in the presence of target
prices. We document a role for the degree of the recommendation change for a
given target price change, suggesting that the degree of the stock recommenda-
tion revision conveys analysts™ uncertainty regarding the overall assessment of
the ¢rm™s prospects.We provide additional evidence as to the dynamic properties
of analyst price targets by examining their long-term comovement relative to
stock prices. Using a cointegration framework, we ¢nd that, on average, one-
year-ahead target prices are 28 percent higher than current market prices, an
estimate that we refer to as the long-term relation of the price system.This frame-
work allows us to document the dynamics that force the two sets of prices to con-
verge on the long-term relation. We show that, while market prices react to the
information conveyed in analyst reports, once the price system has been shocked
away from this long-run relation, any subsequent correction is done primarily by
analysts, while market prices alone contribute little to this correction phase.We
provide evidence that the market understands the latter relationship.
Target prices and, more generally, ¢nancial analysts have recently received
considerable attention. This paper is the ¢rst to explore and document evidence
on the informativeness and time-series behavior of analysts™ target prices, thus
contributing to our understanding of price formation in equity markets. First,
as Asquith et al. (2002) and others document, target prices are often computed
as the product of forecasted earnings and an earnings multiple. Hence, control-
ling for the revision in the earnings forecast, the announcement of a target price
provides researchers with a unique opportunity to observe how investors incor-
porate information on the reduced form˜˜model™™deemed correct by the analysts in
forecasting future price appreciation. Our ¢ndings of a monotonic relation be-
tween abnormal returns and target price revisions, controlling for earnings fore-
cast revisions, is consistent with the view that market participants view the
magnitude of the multiple used by the analyst as informative. Second, the evi-
dence that target price revisions contain information regarding future abnormal
returns is important and consistent with either market underreaction due to in-
vestor behavioral biases or rational learning in the face of structural uncertainty
(Brav and Heaton (2002)). The evidence of such a ˜˜drift,™™ however interpreted, is
also relevant to the current debate regarding the objectivity and unbiasedness of
analyst reports.
Our ¢ndings should serve as a starting point for further research on various
related questions. Since the ratio of target-to-market prices can be viewed as a
measure of ex ante expected return, it would be interesting to examine whether
1964 The Journal of Finance

these ex ante returns are unbiased and are more accurate relative to forecasts
generated from asset pricing models such as the CAPM or intrinsic value mea-
sures such as in Lee et al. (1999). These ex ante expectations can also be used in
asset pricing tests, such as that in Fama and MacBeth (1973), in lieu of realized
returns (see Brav, Lehavy, and Michaely (2002)).
Various other questions warrant further investigation: Are there any cross-sec-
tional di¡erences in market reaction based on ¢rm and brokerage house charac-
teristics? How do analysts determine their target prices? Are these prices based
on valuation models whose inputs include their own earnings forecasts? What
governs analyst decisions to issue or withhold target prices? What, if any, are
the consequences on analysts™ reputations of providing ˜˜incorrect™™ target prices
or ˜˜chasing™™ the stock price? Are any di¡erences to be found in target prices be-
tween˜˜a„liated™™and ˜˜una„liated™™analysts (Michaely and Womack (1999))? Final-
ly, given that the sample period we study is quite unusual in the history of U.S.
capital markets, additional ˜˜out-of-sample™™evidence is desired.We leave these in-
triguing questions for future research.

Appendix: Additional Evidence on the Role of Recommendation Revisions
We report additional tests designed to explore the role of the magnitude of re-
commendation revisions (e.g., hold-to-buy relative to hold-to-strong buy), control-
ling for the information in both target price and earnings forecast revisions. We
expect the magnitude of a recommendation revision to be informative even in the
presence of target prices. For a given target price revision, the magnitude of
the associated recommendation revision can provide additional information on
an analyst™s level of con¢dence in that target price. For example, a positive
revision in a target price could be perceived as more credible (or more precise)
when accompanied by a revision from a hold to a strong buy rather than a revi-
sion from a hold to a buy recommendation. Hence, a target price might re£ect the
mean of the analyst™s posterior beliefs regarding the ¢rm™s value, while a recom-
mendation provides additional information regarding the dispersion of these
We investigate this view as follows. First, we split the sample into two subsets,
depending on the type of the recommendation revisions, namely upgrades and
downgrades. Then, within each such classi¢cation, we consider the possible re-
commendation revisions and regress event-day abnormal returns on an intercept
as well as on earnings forecasts and target price revisions.
The results are presented in Table A1. Consider ¢rst columns 1^3 in which
we focus on recommendation upgrade categories. To ensure a meaningful inter-
pretation of the incremental role of the relative recommendation revision, we
focus on recommendations that were revised from and revised to the same
recommendation.Thus, we compare among three possible such upgrades: (1) hold
to strong buy, (2) buy to strong buy, and (3) hold to buy.
The regression results are consistent with the prediction that, controlling
for earnings forecast and target price revisions, more-extreme revisions in stock
An Empirical Analysis of Analysts™ Target Prices 1965

The Role of Recommendation Revisions
Recommendation Upgrades from Recommendation Downgrades from

Hold to Buy to Hold to Strong Buy Strong Buy Buy to
Strong Buy Strong Buy Buy to Hold to Buy Hold
Variable (1) (2) (3) (4) (5) (6)

À 3.239 À 1.960 À 2.655
a (Intercept) 3.459 2.479 2.670
9.3 13.1 9.3 8.6 9.0 9.2
b (Earnings forecast 0.497 1.051 1.260 0.260 2.443 0.813
revision) 1.0 3.1 3.3 1.4 9.5 3.7
g (Target price 5.639 7.779 4.605 9.093 6.798 8.600
revision) 5.9 12.3 6.4 10.1 10.8 9.4
Adj. R2 5.7 7.9 5.8 14.6 14.3 12.3
N 517 1,879 780 554 1,465 887

recommendations are perceived as providing more-informative signals. For ex-
ample, the coe„cient estimate associated with upgrades to strong buy from hold
(3.459) is signi¢cantly di¡erent (p-value ¼ 0.018) from the one associated with up-
grades to strong buy from buy (2.479). Similarly, upgrades from hold to strong buy
are larger than upgrades from hold to buy, although these di¡erences are margin-
ally signi¢cant (p-value ¼ 0.088).
When we consider recommendation downgrades in columns 4 ^ 6, we ¢nd re-
sults consistent with the hypothesis that the magnitude of a recommendation
revision conveys independent information to market participants. Speci¢cally,
we examine downgrades from: (1) strong buy to hold, (2) strong buy to buy, and
(3) buy to hold. We ¢nd that the coe„cient estimate associated with downgrades
from strong buy to hold ( À 3.239) is signi¢cantly di¡erent (p-value ¼ 0.005) from
the one associated with downgrades from strong buy to buy ( À 1.960). Similarly,
revisions from strong buy to hold are associated with a larger negative abnormal
return than revisions from buy to hold ( À 3.239 vs. À 2.655).These results support
an informative role for the magnitude of recommendation revisions, consistent
with the interpretation that analysts employ the degree of the recommendation
revision to convey their con¢dence in their target price estimate.

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