It took a special kind of incompetence to get to where we are today. After years of "producing" billions of dollars using sophisticated financial instruments, we saw investment banks like Lehman Brothers and nominal retail banks like Citigroup get crushed by the consequences of excessive leverage and convoluted investments. Good thing we've stopped trusting our finances to what those bozos have to say.

Yeah, good thing
Then again, maybe we haven't completely. Case in point: Analyst forecasts.

It's a well-documented fact that analyst earnings estimates tend to be wildly inaccurate -- off by some 40% on average, according to an extensive study by two Penn State professors. Then there's the herd mentality that figures into buy and sell recommendations. In his book One Up on Wall Street, legendary former Fidelity Magellan fund manager Peter Lynch explains why so many Wall Street analysts copy each other, rather than risk their reputations on unusual opinions: "Success is one thing, but it's more important not to look bad if you fail."

See, as my colleagues Brian Richards and Tim Hanson revealed in a recent column, the trouble with analyst price targets is

1. You get no context.

2. The vast majority of stocks -- not surprisingly, for an industry that makes money by convincing you to buy stocks -- are considered "undervalued."

Really? The vast majority?
Yes. According to data I've collected using Capital IQ, an institutional software package, the Wall Street consensus considers fully 85% of S&P 500 companies to be undervalued.

Consider these standouts:

Company

Recent Price

Consensus Target Price

Upside Potential

Southwest Airlines (NYSE: LUV)

$6.31

$11.00

75%

GameStop (NYSE: GME)

$21.83

$32.50

49%

Chesapeake Energy (NYSE: CHK)

$19.56

$28.70

47%

Valero (NYSE: VLO)

$16.03

$22.50

41%

Pfizer (NYSE: PFE)

$14.72

$19.10

30%

While these are excellent companies, and it may be comforting for us to see lofty analyst price targets attached to our stocks, it's absurd to think that the vast majority of the S&P 500 -- an index that captures the most carefully scrutinized publicly traded companies -- would be undervalued.

Remember, many of these recommendations come from the same Wall Street firms that couldn't properly analyze their own businesses. And while that doesn't mean none of them employs very capable analysts or that no stocks are undervalued today (many are), it does raise another problem with price targets.

3. You have no way of assessing the analyst's past record. Continued...