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It isn't hard to create a lengthy list of 1999's market excesses. The top spot would go to the stunning 86% runup in the tech-heavy Nasdaq composite index -- the largest one-year gain in history for a major index. Also somewhere high on the list would be the practically indecent $1,000 price target one analyst set for Qualcomm (QCOM) on Dec. 29. That call set off a one-day rally in the stock of 156 points, or 31%. Qualcomm, which has a central role in developing digital wireless technology, ended the year up more than 2,600%, the top-performing stock in the S&P 500 in 1999.
Analysts are sure to make many other seemingly ridiculous calls in 2000. In fact, the Qualcomm price target is part of a growing trend on Wall Street, where investors have begun making prophets of analysts by driving stocks up to whatever the supposed seers say they're worth.
On Jan. 3, for instance, a handful of Internet stocks scored double-digit gains based on triple-digit price targets, sparking a dramatic run in the sector. Morgan Stanley Dean Witter initiated coverage of DoubleClick (DCLK) with a $300 price target (the stock rose more than 14, to 268), and First Union Securities issued a $600 price target on Yahoo! (YHOO), which rose more than 42, to 475. Another example from 1999: Commerce One (CMRC) was annointed with a $1,000 price target by an analyst from Dresdner Kleinwort Benson on Dec. 20. The stock ran up sharply from that day until it split three-for-one on Dec. 27, but it has since fallen back to close Jan. 3 at 203 5/8 (or $611 pre-split), well short of the target.
CAREER BOOSTER.
This phenomenon "is just a new twist on the old game of the 'bold call,'" says Art Russell, technology analyst with Edward Jones, a regional firm that he says takes a more conservative approach to price targets. But while analysts used to make bold calls in predicting earnings, now they do it with a stock's price target. Some analysts seem to be using their bold predictions as a way to jump-start their careers. "Everybody is fighting for shelf space to get their message out," Russell says. "One way to separate yourself from the crowd is to throw out a price target of several times where the stock is currently. If it does happen, you're a God."
Merrill Lynch Internet analyst Henry Blodget is the grandfather of the stratospheric price target. In December, 1998, while working at CIBC Oppenheimer, he set a $400, 12-month price target for Amazon.com (AMZN), which was then trading at around $240. His seemingly outrageous prediction set off shock waves in the investing community, but the stock zipped past his price target in only three weeks. Blodget, then toiling in obscurity, was soon hired by the more prestigious Merrill Lynch and became one of the most well-regarded Internet analysts.
In the current, momentum-driven stock market, high price targets set by popular analysts quickly become self-fulfilling prophecies -- and investors know it, says Arthur Hogan, chief market analyst at Jefferies & Co. He points out that in Qualcomm's case, the huge one-day runup was fueled by the analyst's call and by an impending four-for-one stock split, which took place on Dec. 30. "Keep in mind, nothing changed at Qualcomm," he says. Still, the stock closed on Jan. 3 at 179 5/16 (717.25 pre-split), which puts it well on its way to Paine Webber analyst Walter Piecyk's $1,000 call. Six days earlier, the stock was at $522.
FORCED HANDS.
Chuck Hill, director of research at First Call Corp, which started collecting price target information along with earnings estimates from analysts about six months ago, notes that Piecyk probably got more ink by making the call pre-split. "It was a clever idea," he says. "If he came out at $250 he wouldn't have gotten so much attention."
Still, analysts often have little choice but to raise price targets -- and find a way to justify new highs -- when stocks they like are moving up rapidly. In fact, many Wall Street firms require analysts to come up with price targets. "The market has a way of forcing their hands," says Alex Cheung, portfolio manager of Monument Internet Fund.
For investors, the important thing isn't so much the price target itself, but how an analyst derives it, Cheung says. If the analyst's justification for why the price will move higher is based on sound reasoning, then there's a reason for holding the stock, agrees Ken Shea, director of equity research at Standard & Poor's. But Shea notes that there seems to be some "shooting from the hip or maybe some compromising on due diligence to come to some of these price targets."
"THAT SCARES ME."
Hogan warns that some analysts use a company that isn't comparable to justify a higher stock price (for example, declaring that a tiny money-losing content site should trade up to Yahoo!'s valuation). Or they may use a stock that's overvalued to justify why a cheaper stock can still go higher. "That's something that scares me," he says.
Piecyk's target on Qualcomm was based on detailed financial models and on his prediction that the company's technology will be adopted by 85% of the mobile phone market (up from 18% now). But in some cases, observers say, price targets are based purely on momentum. While such calls may make the stock rise, "if there is no logical basis for the higher price except the enthusiasm of the people who are buying, you better be ready to jump quickly," says Samuel L. Hayes, a finance professor at Harvard Business School.
For investors, price targets are best viewed as short-term predictions -- not as a real estimate of where the stock will be in a year. After all, business conditions change rapidly in sectors like the Internet or telecom, says Cheung. Kenneth Janke, president of the board of trustees of the National Association of Investors, which helps members organize investment clubs, recommends that investors develop their own price targets based on a company's expected earnings growth over a complete business cycle. Hill points out that few analysts keep their price targets up to date, meaning that the projections often have about a 30-day life.
Of course, price targets aren't all bad. "To me, setting a price target is a logical thing to do in order not to get overenthused in a stock and stay on board longer than you should," says Harvard's Hayes. Now, there's a concept: Instead of a gimmick for driving stocks higher, price targets may be best used by investors as a way to tell when it's time to sell.
Stone is an associate editor at Business Week Online
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