The Effect of Dispersion on the Informativeness of Analyst Target Prices
43 Pages Posted: 21 Oct 2019 Last revised: 7 Feb 2022
Date Written: October 25, 2021
Consensus analyst target prices are widely available online at no cost to investors. In this paper we examine how the amount of dispersion in the individual target prices comprising the consensus affects the predictive relationship between the consensus target price and future returns. We find some evidence that when dispersion is low, returns predicted by consensus target prices are more positively associated with realized future returns. However, we document a strong negative association between predicted and realized returns for stocks with high target price dispersion. Further analyses suggest that this effect of dispersion reflects distortions from analysts being slow to update price targets after bad news. As a stock performs poorly and some analysts are slow to update their target prices, dispersion increases and the consensus target price becomes too high. This has important implications for the informativeness of the consensus analyst target price. Finally, we show that the negative correlation between consensus-based predicted returns and future realized returns for high-dispersion stocks exists mainly for stocks with high retail interest, suggesting that unsophisticated investors are misled by inflated target prices available freely online.
Keywords: analyst forecast, target price, stock return, dispersion, retail investors
JEL Classification: G11, G12, G14, G23, G41, M41
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