Check how much your stock is undervalued

These disciplined processes are taken seriously by the analysts involved and nothing is published by any firm these days without being scrutinised by the compliance department.

Emerging patterns

Take a closer look at the numbers and you will see a number of patterns emerging.

First, there are several media companies, including the publisher of this newspaper, with discounts to the mean target price of more than 30 per cent. It would seem the market is expecting recession like conditions in the advertising sector but the analysts are not.

Even the storied News Corp, which has fallen in value by about 30 per cent from its recent high, is trading at a 23 per cent discount to its mean target price.

Second and third tier resources stocks dominate the list. This may be because rapid movements in commodity prices have not been included in the financial models used by the analysts. The market has moved faster than the analysts.

The list includes several companies which have undertaken large scale international acquisitions funded with large equity issues, such as Worley Parsons and Boral. The market appears to have less confidence in their ability to successfully integrate these acquisitions than the analysts do.

One of the companies with the largest discount to a target price is Lynas Corporation, which has struck political trouble in Malaysia. It seems analysts have yet to update their forecasts to include the worst case scenario, whereas the market has.

Some fast growing companies have very significant discounts to their mean target prices, includingAfterpay Touchat 41per cent andNEXTDCat 27 per cent. It would seem the market is sceptical of the ability of both companies to meet the expectations of analysts.

It is noteworthy that only one of the big four banks is on the list – National Australia Bank. This confirms that analysts are just as bearish as everybody else about the prospects for the banks.

BHP Group and Rio Tinto did not make the grade because the cut-off for the top 100 discounts to target price was 15 per cent. That suggests the analysts who cover the stock are in line with market expectations or the market has moved to their expectations.

Traps to watch out for

Of course, there are many reasons why the financial forecasts prepared by analysts can be out of whack with the market.

Poor performing companies or poorly managed companies trading at significant discounts to their target prices could well be on the brink of announcing profit downgrades. In other words, the discount could be a warning signal rather than a reason to think about buying the stock.

There are other traps for young players. Markets can move a lot faster than analysts, who could be on leave when profit downgrades come through over the quiet period between November and February. There were several notable profit downgrades before Christmas and a couple in the past week.

When told about the findings of the research, a cynic with deep experience in the field of broker research says the numbers could be distorted by industry practices. He says some broking analysts are too easily influenced by the investor relations departments at major companies.

Other analysts allegedly allow their admiration for a company or its chief executive to colour their views of the stock. He says some analysts have consistently issued bullish target prices as part of a strategy for getting a job at the company being covered.

The cynic says some financial forecasts, which influence target prices, are influenced by the long standing relationships between certain companies and investment banks. He says these relationships tend to influence “buy” ratings on stocks.

The research divisions of investment banks are separated from the investment banking operations by Chinese walls which are designed to stop the flow of information between the two.

Analysts are said to be completely independent from investment bankers, but it is uncanny that equity capital market transactions tend to go to investment banks with “buy” recommendations on stocks.

Some investment banks closely monitor discount to median target prices as a way of checking if their analysts are out of touch. Some firms call this the “out of tolerance” check. If an analyst has a target price that is 20 per cent higher or lower than the market price, then the question is asked as to why.


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