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Wall Street Target Prices – Different Meanings to Traders and Fundamental Investors
Hardly a day goes by without another research downgrade
Tesla circa 2019: Encircled by Bears
I remember back in May 2019 when I received an updated Morgan Stanley report on Tesla ($TSLA). Research analyst Adam Jonas published a refreshed bear thesis on Tesla with an eye-catching price target of $10 per share. That was pre-split, and the stock then was trading around $200, a 3-year low. Investors were essentially warned by Jonas of a possible wipeout. Main reason cited for his doomsday scenario:
“The reduction in our bear case to $10 is driven primarily by our concerns around Chinese demand for Tesla products”
Recall in the first half of 2019, Tesla was still undergoing production hell; SEC fraud charges against Elon Musk, though settled, remained topical; and billionaire Jim Chanos was decrying the stock on CNBC to support his shorts. Negativity on Tesla was in vogue, and Jonas’s report got plenty of press. Even as a fundamental investor and a believer in the appeal of Tesla cars, I did entertain the thought closing out my position.
As it turned out, Chinese demand would prove to be anything but lacking. In Q1 2022, Tesla was the best-selling electric vehicle maker in China, and despite supply chain challenges, it is on track to sell more than 1 million cars globally this year.
Looking back, I wonder how many Tesla shareholders capitulated after reading that ominous Morgan Stanley report in May 2019. I assume many did and never returned, missing out on one of the greatest investments of our lifetimes.
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Target Prices: Less Relevant to Fundamental Investors
In recent months, Wall Street has been slashing price targets with aplomb. Key reasons cited were discount rates, macroeconomic factors, and geopolitical tensions. My favorite is peer group compression. Some of the more dramatic reductions include:
Upstart ($UPST) by Goldman Sachs: $250 to $40 (May 2022) and to $14 (Jul 2022)
Unity ($U) by Morgan Stanley: $110 to $50 (May 2022)
Spotify ($SPOT) by JP Morgan: $280 to $150 (April 2022)
Few have correlated with company-specific fundamental deteriorations. Most are just moving in sync with overall market direction. It is noted that target prices set by Wall Street are formulated within the standard 12-month timeframe; accordingly, they are less relevant to investors with decade-plus horizons. But the current wave of bearishness infecting Wall Street creates an almost irresistible temptation for growth investors to give up on their holdings. The worry is that share prices for former high-flyers may never recover, and it is better to cut losses now.
Convictions versus Head in the Sand
For companies that are still executing well on their strategies, fundamental investors should ignore price targets, unless they want to trade in and out of their holdings, but timing the market for short-term profits is a different ball game altogether. Every multi-bagger – including the likes of Apple and Alphabet – has gone through periods of massive price drawdowns, attracting Wall Street bears along the way. And prior to 2022, Wall Street was issuing higher and higher 12-month targets for many hot technology stocks; years of potential returns were pulled forward as bull fever swept the markets. Overpaying, even for great companies, can contribute to meaningful underperformance.
Some price cuts, however, can be canaries in a coal mine. Peloton is one such example. It was mismanaged by previous leadership, despite of having great products and loyal customers. Current uncertainty over operational capabilities as well as changing management teams are valid concerns to warrant a full reversal on the fundamental thesis and capitulations.
It is important to make distinctions between noise and red flags, and distinguish short-term sentiment shifts from enduring growth stories. Holding secular winners is never linear – all of them have gone through growing pains.
For fundamental investors in a bear market hunting for the next generation of Amazons, retaining convictions in the face of Wall Street mood swings is essential.
Keep calm and carry on.
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