Ask TheStreet: Target Practice

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Can someone please explain the logic behind stock-price targets? When an investment bank announces a price target for a stock, what exactly does it mean? More often than not, it seems that their price targets are too high, leading me to question if we should even give any consideration to them. -- J.N.

Gregg Greenberg: When famed research analyst Henry Blodget set a $400 price target for Amazon.com (AMZN Quote - Cramer on AMZN - Stock Picks) in December 1998, it was akin to Babe Ruth calling a home run by pointing to the outfield bleachers with his bat. Back then, analysts were the giants of Wall Street, calling the shots and earning huge paychecks for it.

Like in baseball, however, times have changed on Wall Street. Nowadays, the situation regarding price targets is more like a Barry Bonds homer.

Yeah, it's out there and garners attention, but its validity is questionable. That's why investors are best served by looking at analysts' target price as guidance and not as gospel.

Research analysts spend their days trying to find values for the stocks they cover. It's not an easy job because there are so many variables at play. And the targets aren't affected just by company-specific variables, like earnings and sales, but also by external ones, like interest rates and the overall health of the global economy.

With so many factors up in the air, it's absolutely impossible for analysts to calculate the exact price of a stock. The best they can do is offer a target so investors can get a sense of their opinion and conviction of the overall direction of the stock.

Targets are created predominantly through different valuation techniques, such as sum-of-the-parts (valuing the company by adding together what its segments would be worth if they were broken up), price-to-earnings comparisons or discounted cash flow (a complicated analysis of cash projections). These aren't exact sciences -- and very often the results will conflict even on the same stock -- but each method is useful in its own way when valuing a company.