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Sound Advice: March 27, 2024

“Barclays cut Apple’s rating to underweight and trimmed its price target to $160 from $161.”

That kind of headline coming from what might be considered a respectable financial institution is worthy of nothing more than an eyeroll.  A $1 cut?  Really?  Why not a 52¢ cut or some other adjustment of equal embarrassment.

Although Wall Street analysts tend to fantasize about their ability to project the future, there is no reason to believe they have any gifted vision of what’s to come.  Much of the work done by analysts focuses on prospective rates of growth in revenues, earnings, and capital expenditures needed to support the accelerated pace that may be developing.

Within the broad parameters of looking ahead, one might be tempted to work the way downward through a profit and loss projection to specify a range of profitability that may be within reason several years down the road.  Applying that range to the stock’s recent rates of valuation (price-earnings multiples) would yield a band of prices that might be attainable ahead.  That approach is what points toward price targets.

All of which are utter and complete nonsense.

Perish the thought of people sufficiently naïve to believe that portfolios should be constructed of stocks with the broadest differential between current prices and those silly target prices.  The variables involved are far too shaky to give serious thought to using such an approach.

The profit and loss picture alone is a minefield.  Simply extrapolating current trends is nothing more than rolling the dice.  What’s strong today may be weak tomorrow.  What about the possibility of increased competition or changes in tax rates?

And then there’s the matter of valuations.  Stock valuations are heavily dependent on company growth rates. Over time, company growth rates tend to moderate as volume increases.  That’s known as regression to the mean.  As growth rates slow, investors’ expectations are lowered and valuations shrink.

If profits continue to expand, that expansion needs to be generated by higher ongoing revenues.  When reported profits climb without a proportionate jump in revenues, it’s likely that this increase is from a nonrecurring item (e.g., sale of assets), which has no impact on a stock’s price.  Recurrence is the key.

The formula is straightforward: As earnings rise, so will stock prices over time.  The critical phrase is “over time.”  In the interim, volatility is always part of the equation.

Bottom line: Any analyst foolish enough to present precise miniscule changes to prospective stock price targets would be better served counting grains of sand on a beach.  It’s OK to be a fool, but please don’t prove it.

N. Russell Wayne

Weston, CT

Any questions: please contact me at nrwayne@soundasset.com

203-895-8877

www.soundasset.blogspot.com

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