Estimating the future price of a stock is key to
making profitable buy and sell decisions. Here is a simple and quick
procedure that uses estimated earnings and a selected price-to-earnings
ratio (P/E).
- Select the stock to analyze.
- Look up analyst estimates for future earnings (usually one year
out) from Yahoo!
Finance or another financial site of your choosing. For Yahoo!
Finance enter a stock's symbol and then click on Analyst Estimates
in the left hand column of the stock's summary page.
- Next select a price to earnings ratio that applies to the sector
in which the stock resides. Check Yahoo! Finance or another financial
site for P/Es of like companies in a given sector. Fast growing
companies usually have a higher P/E than slower growing ones.
- Then multiply the earnings estimate by the selected P/E, and
you have the estimated stock price.
Obviously there will be an error associated with your estimate
because the earnings estimates will not be completely accurate and
the P/E ratio that you select is subject to interpretation; different
people will select different P/E ratios. To account for these errors
apply a plus and minus percentage error to your price estimate.
The magnitude of the error depends on your confidence in the estimates
of earnings and P/E. If you are comfortable with the earnings estimates
and the selected P/E, apply a small error; otherwise use a larger
error.
Here is an example for Google's (GOOG)
target price for 2008. From Yahoo!
Finance I decided on a 2008 earnings estimate of $20 and applied
a P/E of 30 to arrive at a target price of $600. Applying a plus
or minus 10 percent error ($60) gives a target price range from
$540 to $660.
For the S&P 500, a 2008 earnings estimate of $80 with an expected
P/E of 25 gives an estimated target of 2,000. Applying a plus or
minus 10 percent error ($200) gives a target price range from $1,800
to $2,200.
Related Article:
Estimating Future Prices
Price-to-Earnings Ratio
Valuation Measures
Posted July 25, 2007.
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