REPEAT Rudi’s View: Daily Icarus Signal

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

(This story was originally published on Wednesday, 18 June 2011. It has now been re-published to make it available to non-paying members at FNArena and to readers elsewhere).

FNArena has launched a new service on its website; The Icarus Signal. Following on from my past analyses and observations, this new service will make it easier for FNArena subscribers to keep up-to-date with which stocks are approaching consensus targets, which stocks are above targets and which stocks are well-well-well below targets. The new service on the website is complemented with a daily news flash that will report on noticeable changes and important background information. Both new additions are now available in emails and on the website.

To celebrate the newest addition to the FNArena service (another unique research tool) we offer ex-trialists the opportunity to have another in-depth look at our service, including the Icarus Signal. If you are interested in another trial, send us an email at info@fnarena.com for another obligation free, two week trial to our service.
 

By Rudi Filapek-Vandyck, Editor FNArena

Price targets are not the end all and be all when it comes to analysing and investing in individual stocks in the Australian share market. Those who own shares in BHP Billiton ((BHP)) have seen the gap widen in recent weeks as the share price pulled back while targets kept on rising. With global economic data back in "questionable" territory and overall risk appetite less than bullish, it remains yet to be seen whether investors will witness BHP shares closing the gap with FNArena's consensus price target anytime soon. With the target at $53.98, the gap is now more than 22%.

On the other end of the scale sits Matrix Composites & Engineering ((MCE)), one of the star-performers in the share market last year. Only one of eight regular stockbrokers in the FNArena universe covers the stock and JP Morgan simply cannot justify anything near the current share price. No second guessing why the sole rating on our service reads "Underperform". MCE's share price has weakened quite a bit since it rallied to $10 earlier this year, but even at $8.14 the share price still trades more than 35% above what JP Morgan thinks the shares are worth right now.

Of course, one stockbroker on its own cannot generate a "consensus" price target and the whole reasoning behind calculating consensus price targets is to reduce the flaws that come with relying on one single expert. That, however, still provides no guarantees. Cochlear ((COH)) does enjoy wide and varied in-depth coverage and its shares have now traded above consensus price target since November last year. There have been temporary pullbacks to below target and there have been fruitless attempts to rally higher over the period. On balance, however, the share price is still around $80, which is exactly the price investors paid in late November.

None of the above means target prices have no practical value and they should be ignored. Take Cochlear as an example. Ever since the share price moved above target last year I have cautioned, both in writing and on TV, that investors should not chase the stock as it is poised to generate disappointing investment results. Cochlear, trading on a Price-Earnings multiple of 25, pays a dividend of less than 3%. I still caution the risks are to the downside and with the multiple at 25, there's not much room for disappointment. Certainly, less than 3% in annual dividends is not going to provide any meaningful buffer in case momentum does reverse.

Apart from ignoring consensus targets completely, I think the biggest mistake investors can make is to consider these targets as sacred and unchangable. Sometimes the share market runs ahead of securities analysts, which then causes targets to play catch-up. This is what happened in the final quarter of last year, when companies exposed to miners' capex intentions for the coming years all saw their share prices surge to well above stockbroker targets. In some cases targets subsequently had to catch up. In other cases, the share price has now come down.

Paying attention to consensus price targets is not something that can be fully automated. Every time a given share price approaches or exceed its target, the key question investors should ask is: what are the chances this company deserves a higher valuation than is currently being projected by the analysts? Second question: and if valuations/targets were to rise in the short term, will it make much of a difference?

The most obvious sector for which these questions have served their purpose in the past are the Australian banks. It is my long standing observation that when share prices for major banks in Australia exceed their price targets, investor risk appetite is "bubbling" up too high and more often than not the share market will set itself up for some serious legwork to the downside. I have written many times in the past about the banks and their targets, and the chart below suggests my personal market indicator remains alive as ever. Observe how Westpac ((WBC)) shares temporarily rose above consensus target in February and in May this year; on both occasions Australian equities went into correction mode soon afterwards.

The banks are not the only ones for whom these targets provide near perfect warning signals. Shares in Coca-Cola Amatil ((CCL)) repeatedly tried to rally above target in the fourth quarter of last year until they ultimately were rejected and fell to much lower prices. Investors who last year bought at $12.50 or higher are still in the red, even if we include the dividend payouts since then. And shares in Monadelphous ((MND)) which rallied beyond $22 in March have now pulled back to below consensus price target; a difference in share price of $3 in less than two months.

Two observations stand out: consensus price targets work best for companies with a reasonably straightforward set of business characteristics. Being a bank is pretty straightforward, and so is selling fizzy drinks and fruit in cans. Being an explorer with metals in the ground, no sales and some cash in the bank is everything but. And that's not even mentioning single product producers whose bottom line is highly leveraged to price movements on international commodity markets.

Secondly, consensus price targets work much better as a signal of caution (on the upside) as when they suggest a bargain opportunity when share prices are well-well-well below targets. In the latter case, when a share price is 30%, or 40%, or 50% below target, it is far more likely the market has decided this stock is no longer "investment grade" and best left to small cap daytraders and their daily cravings for maximum volatility.

A few examples of stocks that are trading well below their target are Gryphon Minerals ((GRY)), Penrice Soda Holdings ((PSH)), ERM Power ((EPW)), Silex ((SLX)), PaperlinX ((PPX)) and Texon Petroleum ((TXN)). There are at least 50 others. Some of these companies have run into serious trouble, others are unknown and have yet to prove themselves. All have one thing in common; there's at least one major stockbroker out there that researches them and is willing to place a valuation on the shares that is much higher than where the share price is today.

FNArena has created a daily update for those stocks in our universe that are trading well below price target. Our website will display a table with the 50 stocks that are farthest away from their target. Looking at the list of stocks, and at the daily volatility that many of these stocks have displayed in recent times, I have a suspicion we have re-created heaven for daytraders looking for potential toys. For all others: keep in mind these stocks do not represent low risk, valuation bargains. They come with high risk and might never fulfill their assumed potential.

Of more interest, in my view, is the daily overview of stocks that are approaching their target. Will they face rejection, just like the examples of Westpac and Coca-Cola Amatil mentioned above? Or will they extend their rally first and then pull back to target, just like in the case of Monadelphous?

In both cases, even including the example of Cochlear, the conclusion at the time of the stock reaching target remains the same: disappointing returns ahead (not guaranteed negative). Investors better pay attention. If you are a paid subscriber to FNArena you will soon have the ability to keep track on a daily basis.

FNArena has created a third daily overview of stocks trading above target. As one would expect, this particular list contains many stocks under scrutiny from corporate suitors, including Equinox ((EQN)), Warrnambool Cheese and Butter Factory ((WCB)) and Oaks Hotels & Resorts ((OAK)). It would be a mistake to assume these share prices are ripe for a pullback, unless the prospect of a full take-over disappears. Which is why FNArena will soon start publishing a daily update about these tables in which we will try to keep subscribers up to date on these matters.

Another observation worth pointing out is that many stocks trading above target are only covered by one stockbroker. Yes, the concept of a "consensus" price target does not rhyme with having only one expert projection, but we thought you might still want to know. That's why our tables don't discriminate and display all the stocks that meet the criteria for either approaching their target, exceeding it, or trading well below target. And yes, we update and show changes to targets too.

In all three tables the same underlying message applies: don't treat anything we show with automatic pilot and don't consider anything as an exact science. Apart from that, I am certain that if investors allow themselves to get acquainted with FNArena's consensus price targets, in a similar fashion as I did without these daily overviews, I am sure they will grow to appreciate them as a useful tool in their analysis and their strategies, just like I have done.

As an appetiser prior to the launch, below are the three tables that will soon be updated daily on the FNArena service. Enjoy.

Stocks <3% Below Consensus

Stocks Above Consensus

Top 50 Stocks Furthest from Consensus

FNArena. Once you get used to us, you'll never again look at the share market in the same way.

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website.

P.S. II – If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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