• Sharebar

I'm not sure if this is a stupid question or not, but I'll go on with it. So one of the purposes of issuing research reports is to influence investors' decisions on trading the underlying assets, and the target prices are predictions of the price movements in the future. Now assume that an analyst has made a perfect forecast on one stock's price, and every potential macroeconomic & market factors are captured by the report. Smelling something now? This is where the contradiction kicks in. If stock prices can be influenced by the issuance of research reports, then all research reports would never be accurate in their target prices because they do not capture the ex ante effect of how their reports might influence the market. If the hypothesis above is true, then I suspect a great concern to the reliability of research reports. And in the future, analysts might have to incorporate assessments of their credibility as a proxy to measure their report's materiality.

What do you guys think?

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Comments (10)

  • jointhebank's picture

    I am a newbie so don't know much but I am constantly learning. I came across the EMH recently which might answer this.

    Efficient Market Hypothesis with 3 cases: weak, semi-strong, strong-form. The strong-form EMH suggests that the market instantly reflects even hidden information - but this clearly isn't true. So it all comes down to inefficiencies in the market, and how it cannot take into account all factors even if they are predicted accurately. Add to that the amount of information that is not publicly disclosed and then the many derivatives and "bets" which disrupt the EMH even further.

    I'm sorry if I am being stupid, and would appreciate anyone correcting me. :)

    Being a prospective monkey I am bound to post stupid comments due to my lack of expert knowledge. I implore you to correct me harshly or constructively, and I will appreciate any learning opportunity.

  • In reply to jointhebank
    tonydaboiii's picture

    jointhebank:
    I am a newbie so don't know much but I am constantly learning. I came across the EMH recently which might answer this.

    Efficient Market Hypothesis with 3 cases: weak, semi-strong, strong-form. The strong-form EMH suggests that the market instantly reflects even hidden information - but this clearly isn't true. So it all comes down to inefficiencies in the market, and how it cannot take into account all factors even if they are predicted accurately. Add to that the amount of information that is not publicly disclosed and then the many derivatives and "bets" which disrupt the EMH even further.

    I'm sorry if I am being stupid, and would appreciate anyone correcting me. :)

    2 things.

    1) Studies suggest that the reality is leaning towards more to the semi-strong form.

    2) Perfect prediction is only hypothetical. My hypothesis is that even a report has taken into account of every market factor that might affect that particular stock's price, the analyst still wouldn't be able to make the perfect estimation to the target price because the target price doesn't capture the potential market influence of the report. And the credibility of the analyst/his company might be able to reflect "how influential the report will be".

  • In reply to tonydaboiii
    jointhebank's picture

    tonydaboiii:
    jointhebank:
    I am a newbie so don't know much but I am constantly learning. I came across the EMH recently which might answer this.

    Efficient Market Hypothesis with 3 cases: weak, semi-strong, strong-form. The strong-form EMH suggests that the market instantly reflects even hidden information - but this clearly isn't true. So it all comes down to inefficiencies in the market, and how it cannot take into account all factors even if they are predicted accurately. Add to that the amount of information that is not publicly disclosed and then the many derivatives and "bets" which disrupt the EMH even further.

    I'm sorry if I am being stupid, and would appreciate anyone correcting me. :)

    2 things.

    1) Studies suggest that the reality is leaning towards more to the semi-strong form.

    2) Perfect prediction is only hypothetical. My hypothesis is that even a report has taken into account of every market factor that might affect that particular stock's price, the analyst still wouldn't be able to make the perfect estimation to the target price because the target price doesn't capture the potential market influence of the report. And the credibility of the analyst/his company might be able to reflect "how influential the report will be".

    I assume the credibility is built into how popular a certain institution's ER is? Also given how that hypothesis is very unreal - due to inefficiencies - I would assume it barely makes any effect on the performance of the stock?

    This is very similar to my earlier confusion about how stocks can go up simply by overbuying (in large quantities) and then dumping it back for profits. I guess there are SEC regulations on how much you can buy before filing some form, but it essentially boils down to how the market gets back to 'equilibrium' after any external disturbance. Similar to any "event" in the stock - like death of CEO or a terrorist attack - which drops the price but recovers to pre-event levels soon after.

    Being a prospective monkey I am bound to post stupid comments due to my lack of expert knowledge. I implore you to correct me harshly or constructively, and I will appreciate any learning opportunity.

  • In reply to jointhebank
    tonydaboiii's picture

    jointhebank:
    tonydaboiii:
    jointhebank:
    I am a newbie so don't know much but I am constantly learning. I came across the EMH recently which might answer this.

    Efficient Market Hypothesis with 3 cases: weak, semi-strong, strong-form. The strong-form EMH suggests that the market instantly reflects even hidden information - but this clearly isn't true. So it all comes down to inefficiencies in the market, and how it cannot take into account all factors even if they are predicted accurately. Add to that the amount of information that is not publicly disclosed and then the many derivatives and "bets" which disrupt the EMH even further.

    I'm sorry if I am being stupid, and would appreciate anyone correcting me. :)

    2 things.

    1) Studies suggest that the reality is leaning towards more to the semi-strong form.

    2) Perfect prediction is only hypothetical. My hypothesis is that even a report has taken into account of every market factor that might affect that particular stock's price, the analyst still wouldn't be able to make the perfect estimation to the target price because the target price doesn't capture the potential market influence of the report. And the credibility of the analyst/his company might be able to reflect "how influential the report will be".

    I assume the credibility is built into how popular a certain institution's ER is? Also given how that hypothesis is very unreal - due to inefficiencies - I would assume it barely makes any effect on the performance of the stock?

    This is very similar to my earlier confusion about how stocks can go up simply by overbuying (in large quantities) and then dumping it back for profits. I guess there are SEC regulations on how much you can buy before filing some form, but it essentially boils down to how the market gets back to 'equilibrium' after any external disturbance. Similar to any "event" in the stock - like death of CEO or a terrorist attack - which drops the price but recovers to pre-event levels soon after.

    Word. My opinion is that while in the long term the stock price would revert to a price level corresponding to the stock's fundamental value, but in short-term the effect of a research report (or think of a roadshow) would still be significant.

  • In reply to newfirstyear
    tonydaboiii's picture

    newfirstyear:
    Target prices don't mean anything. Reports, ratings and price targets are not how ER analysts add value, nor seek to add value.

    I see, then how do they add the values?
  • cluelessjoe's picture

    I agree with newfirstyear on this one. From my limited interviews with ER teams, I gathered that their real value was in connecting investors to corp. management teams and hosting road shows, acting somewhat like a gatekeeper. I think that the research reports are more or less there to generate publicity for the ER's brokerage team, being a sort of soft-dollar freebie.

  • SmokeyTheBear's picture

    If you're interested in finding out more about the connection between how all the information is connected and causes change, check out "The New Paradigm of Financial Markets" by Soros. I'm reading through it now and it goes over his "theory of reflexivity". It can be heavy at times, but it's worth it to grind through it.

  • In reply to SmokeyTheBear
    tonydaboiii's picture

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  • In reply to tonydaboiii
    KarateBoy's picture

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