A Prsentation
Importance of this topic
The context is application of Modern Portfolio theory (MPT).
MPT – Harry Markowitz proposed it in 1952.
The model requires expected return and standard deviation estimates for each security to be considered for inclusion in portfolio.
It also requires estimation of correlation coefficients for each possible pair of securities.
Each possible pair means, for three securities a, b, and c; ab, bc and ca are three possible pairs.
For four securities a, b, c and d; ab, bc, cd, da, ac,bd are six possible pairs
How to get expected return of a security
Target price models help us to determine the expected return.
Exp. Return =100* [Target price – Current Mkt Price]/Cur. Mkt Price
Target Price
A target price for a stock is a figure published by a securities industry person, usually an analyst.
The idea is that the target price is a prediction, a guess about where the stock is headed.
Target prices usually are associated with a date by which the stock is expected to hit the target. (normal practice 12 months)
http://invest-faq.com/articles/adv-target-price.html
The projected price level as stated by an investment analyst or advisor.
A stock trading at $60 might have a one year price target of $90.
http://www.investopedia.com/terms/p/pricetarget.asp
Target price model is a fundamental analysis technique.
Fundamental Analysis
Based on operating and financial performance of companies
Value based
Target price based
Quantitative judgment
Qualitative judgment
Past performance Basis
Projected performance basis
Judgment on positive or negative effect on future performance of news event.
Why Target Prices Are Better for Investors than a Rating?
Rick Wayman, CFA (ResearchStock.com)
http://www.investopedia.com/printable.asp?a=/articles/analyst/03/022603.asp
Because they provide additional information that an investor can use to determine if a stock is right for him or her, target prices are better than ratings.
Good Research Report
A target price is an estimate of a stock's future price based upon an earnings forecast and assumed valuation multiples.
A good research report will present its case for a target price by presenting detailed information.
Four key aspects
Investors need to evaluate the following four key aspects for determining the "legitimacy" of a target price:
1. the EPS forecast,
2. the assumptions underlying the EPS forecast,
3. the valuation multiples used, and
4. the rationale for using those valuation multiples.
How investors can judge these factors?
1. EPS Forecast
This is the foundation of the target price, and the report should contain a detailed earnings forecast model.
(full income statement with a discussion of operating cash flows) for the time frame covered by the target price (preferably two years).
A quarterly forecast for the next 12 months is useful for tracking the accuracy of the analyst and for keeping an eye on whether or not the company is performing as anticipated.
2. EPS Forecast Assumptions
The report should also discuss the assumptions used to make the forecast so that the reader can evaluate their reasonableness.
A report's lack of both a detailed earnings model and list of assumptions should be a warning sign to investors.
It is important that the assumptions be reasonable.
For example, in the current economic environment it is highly unlikely that a micro-cap company whose sales have grown at a 1-2% pace during the last two years will be able to accelerate sales growth to a double digit pace in the coming two years.
A good research report will provide the reasons why the analyst expects a big jump in sales growth
(for instance, the company may have acquired a new product or patent).
A detailed earnings model is provided so that the reader can adjust the assumptions (e.g., reduce sales growth expectations) to calculate the impact on EPS and valuations.
3. Valuation Multiples Used to Calculate the Target Price
The next building blocks of target prices are valuation multiples, such as price/earnings (P/E), price/book (P/B), and price to sales (P/S).
You need to make sure that the type of valuation multiples used are applicable to the stock you are researching.
For example, the market places more emphasis on P/E multiples for industrial companies and a P/B multiple for banks.
In addition to using the right multiples, the valuation model should be based on more than just one variable.
A valuation model based on one multiple is like a one-legged stool: not very sturdy or reliable.
While the market may place more emphasis on one multiple over another, a good model consists of at least three variables.
Three good multiples for industrial companies are P/E, P/B, and P/S.
Bank prices, on the other hand, are
typically based on P/B, to a lesser extent on P/E, and on price/total income
4. Assumptions Used to Justify the Valuation Multiples Used
Assumptions, whether they are used to support an earnings forecast or valuation target, need to be reasonable.
This can be determined by looking at the assumptions and comparing them to historical trends, a relevant peer group (i.e. companies, possibly competitors, that are in the same business), and current economic expectations.
Don't worry; this is not as hard as it sounds.
In order to make a good case for a target price, the analyst should include a discussion of the historic trends and an analysis of these trends through a comparison to a relevant peer group.
If a stock has consistently traded below its peer group average (has been a “discount”) and the forecast expects the multiples to be larger than the peers (to be a “premium”), you need to evaluate the reasons why the market is expected suddenly to “discover” the stock.
While there are occasions when valuations “pop” (such as when a company gets an FDA approval to market a drug), they are high risk/reward situations and only investors with that type of risk tolerance should accept those assumptions and invest in this type of situation.
There are situations, however, where a stock is legitimately undervalued because the market is not aware of its fundamentals—the company is literally waiting to be “discovered.”
This is a lower risk situation, but it may take a long time before the market adjusts the stock's valuation.
The Bottom Line
Investors will make better decisions if they focus on target prices, which convey more information for evaluating the potential risk/reward profile of a stock.
A good target price is based upon a reasonable set of four factors that provide the reader with information to determine the accuracy of the target price.
The absence of any of these four factors should be a red flag that the so-called report could really be a "pump and dump" marketing ploy
UBS Practices
Genzyme General
Biotechnology
United States
Our one-year price target is $32, 23 times our 2003 EPS estimate of $1.40
Daishin Securities
Securities Brokers
Korea
The target price is the average of implied fair value calculated at a 5% discount to target sector multiple.
The multiples are estimated for Trailing P/BV, 12 month Prospective P/BPCS, 12M Prosp P/CIPS, 12M Prosp. P/NORPS, FY03 P/E, and FY03 P/PpoP.
People’s Food
Food Products
Singapore
Target Price is our DCF estimate for the stock.
Aeroflot
Transport
Russia
For valuing airlines, we prefer the EV/OpFCF multiple over the more traditional P/E and EV/EBITDA ratios, as it accounts for the various balance sheet structures and depreciation methods used by different companies.
However, we believe EV/OpFCF shows only part of the picture.
We believe a more reliable valuation metric is implied franchise value of an airline, measured by comparing its enterprise value with the substitution cost of its fleet.
Hence EV/FSC is to be used.
We expect that by 2002E Aeroflot will trade at an average emerging market EV/FSC of 0.75.
Applying this to the 2002E fleet substitution cost of $2,615 m and 2002E net debt of $778 e arrive at an implied forward market capitalization of $845 m.
Sarna Chemicals,
Commodity
Europe
At our target price, Sarna would trade on 5.2x EV/EBITDA.
This represents 15% discount to the European auto parts sector.
Our valuation is supported by our DCF calculation, which derives a price of CHF2,523 per share.
We have applied a 23% discount to get our target price of 1,950 owing to (1) lack of liquidity; and (2) the relatively low capitalisation of the stock.
Sum of parts valuation
30th May 2000
Computer & Tech
Technology Software,
Hongkong
We base our 12 month price target for C&T on 20x 2002E China earnings for China Business and
50x 2002E e-commerce enabling (or GeBE) earnings.
Added to this is our valuation of the ASP division (or GeBS), which we value on 50x our 2002E revenue projections of HK$16m
P/E multiple
July 25, 2002
CNH Global N.V.(CNH)
Machinery
USA, July 25, 2002
Our 12 month target price assumes that CNH trades to roughly 10 times potential 2004 earnings of roughly $0.70 per share.
Premium over market multiple
December 4, 2002
Network Appliance (NTAP)
PC Hardware, Application software, Enterprise Hardware
United States,
We believe a normalized P/E for the market is somewhere in the low 20X range.
If we apply a 100% multiple premium (which is at the low end of NetApp’s historical range) to our estimate of NetApp’s normalized earnings of $0.40, we arrive at our price target of $18/share.
Reduction in DCF value
14 Mar 2002
The Gribbles Group (GGL.AX)
Healthcare Providers
Australia
As a result of the reduced earnings forecast, our DCF has declined to $1.00 (from $1.17), Price target $1.00 (from $1.17)
Discount to sector multiple
17 July 2002
Tamedia
Publishing
Switzerland
Our new price target of CHF 100 would value Tamedia at 6.5x 2003E EV/EBITDA, implying a discount of c20% to the European media sector.
Price/Book value multiple
10th January 2003
ESEC
Semiconductors
Switzerland
Our price target of CHF72 implies a price/book of 1.1x.
The current price at 1.6x 2002E remains well above the historical average (1998-2001) of 1.2x
Premium to sector multiple – International market
September 27, 2002
Nokia
Wireless Equipment
United States
Our price target of EUR 20 (US$20) is based on a 2003P/E of 23x, compared to European Tech at 17x.
We believe the premium is justified in view of Nokia’s superior margin, cash generation and growth outlook.
Showing posts with label Target Price. Show all posts
Showing posts with label Target Price. Show all posts
Thursday, December 6, 2007
Tuesday, December 4, 2007
Criticism of Target Prices - New York Times Article
http://query.nytimes.com/gst/fullpage.html?res=9F05E1D8123CF936A3575BC0A9679C8B63&sec=&spon=&pagewanted=all
MARKET WATCH; Price Targets Are Hazardous to Investors' Wealth
By GRETCHEN MORGENSON
Published: August 5, 2001
Important Points Made
On Dec. 5, 2000, Andrew J. Neff, a computer analyst at Bear, Stearns, issued a report on Palm Inc., with a 12-month price target of $80 on the shares, reflecting his belief that they would trade at 19 times his 2001 sales estimate for the company.
By the next week, Palm shares had climbed to $56.625. But then they began to sink, until, on Jan. 3, they had reached $27.88. That day, Mr. Neff cut his target to a range of $37 to $48. Two months later, with Palm in the mid-teens, Mr. Neff lowered his target again. Finally, on May 17, the shares stood at $7.05 when he slashed his target to around $5. It closed on Friday at $5.36.
This is an example of the assignment of target prices that were based more on fantasy than reality.
According to Stefan D. Abrams, chief investment officer for asset allocation at the Trust Company of the West in New York, these target prices could not be defended by any rational means and these were nothing more than sales hype.
Early in the mania, of course, investors who bought stocks based on wild targets did well. Amazon.com blew through Henry Blodget's famous $400 target about a month after he assigned it in December 1998. And for every seemingly crazy target that was subsequently met, the next one became more credible.
Big and bold price targets are a relatively new phenomenon in Wall Street research reports. In the 1980's, an analyst might estimate a range within which a stock could trade, based on what the analyst expected the company to earn. But such targets were low profile and typically surrounded by caveats.
Robert A. Olstein, manager of the Olstein Financial Alert fund, said ''Today's analysts are soothsayers, because they're trying to predict where the crowd frenzy is going to take a stock,''
Said Mitch Zacks, vice president of Zacks Investment Research in Chicago, ''The price target is the piece of data produced by Wall Street that is least tied to reality,''
RiskMetrics, a software analytics company based in New York that specializes in risk assessment for the financial community, recently conducted a study for Money & Business that examined 550 price targets assigned to some 300 technology stocks as of June 22. It looked at five major Wall Street firms' targets for companies in computer software, hardware and semiconductors, and calculated the probabilities that these targets would be met within the next 12 months. The firms are Goldman, Sachs; Merrill Lynch; Morgan Stanley Dean Witter; Prudential Securities; and the Salomon Smith Barney unit of Citigroup.
While many of the targets had a better than 50-50 probability of being met based on past price action, 46 companies carried targets that had less than a 20 percent chance of being hit.
''There's no consistency even within a brokerage house in the creation of a price target,'' said Michael Thompson, RiskMetrics' global market commentator. ''Too many times, these things come out of the air.''
The RiskMetric study showed that the Prudential analysts had the highest percentage of price targets that were most likely to be reached -- 67 percent. Salomon Smith Barney took second place with 64 percent, followed by Merrill Lynch at 58 percent and Morgan Stanley at 57 percent. Goldman was last, at 49 percent.
A word of caution on these figures: this study was focused on one sector of the economy and based on data collected without the firms' help. The results could be quite different for research in other sectors.
MARKET WATCH; Price Targets Are Hazardous to Investors' Wealth
By GRETCHEN MORGENSON
Published: August 5, 2001
Important Points Made
On Dec. 5, 2000, Andrew J. Neff, a computer analyst at Bear, Stearns, issued a report on Palm Inc., with a 12-month price target of $80 on the shares, reflecting his belief that they would trade at 19 times his 2001 sales estimate for the company.
By the next week, Palm shares had climbed to $56.625. But then they began to sink, until, on Jan. 3, they had reached $27.88. That day, Mr. Neff cut his target to a range of $37 to $48. Two months later, with Palm in the mid-teens, Mr. Neff lowered his target again. Finally, on May 17, the shares stood at $7.05 when he slashed his target to around $5. It closed on Friday at $5.36.
This is an example of the assignment of target prices that were based more on fantasy than reality.
According to Stefan D. Abrams, chief investment officer for asset allocation at the Trust Company of the West in New York, these target prices could not be defended by any rational means and these were nothing more than sales hype.
Early in the mania, of course, investors who bought stocks based on wild targets did well. Amazon.com blew through Henry Blodget's famous $400 target about a month after he assigned it in December 1998. And for every seemingly crazy target that was subsequently met, the next one became more credible.
Big and bold price targets are a relatively new phenomenon in Wall Street research reports. In the 1980's, an analyst might estimate a range within which a stock could trade, based on what the analyst expected the company to earn. But such targets were low profile and typically surrounded by caveats.
Robert A. Olstein, manager of the Olstein Financial Alert fund, said ''Today's analysts are soothsayers, because they're trying to predict where the crowd frenzy is going to take a stock,''
Said Mitch Zacks, vice president of Zacks Investment Research in Chicago, ''The price target is the piece of data produced by Wall Street that is least tied to reality,''
RiskMetrics, a software analytics company based in New York that specializes in risk assessment for the financial community, recently conducted a study for Money & Business that examined 550 price targets assigned to some 300 technology stocks as of June 22. It looked at five major Wall Street firms' targets for companies in computer software, hardware and semiconductors, and calculated the probabilities that these targets would be met within the next 12 months. The firms are Goldman, Sachs; Merrill Lynch; Morgan Stanley Dean Witter; Prudential Securities; and the Salomon Smith Barney unit of Citigroup.
While many of the targets had a better than 50-50 probability of being met based on past price action, 46 companies carried targets that had less than a 20 percent chance of being hit.
''There's no consistency even within a brokerage house in the creation of a price target,'' said Michael Thompson, RiskMetrics' global market commentator. ''Too many times, these things come out of the air.''
The RiskMetric study showed that the Prudential analysts had the highest percentage of price targets that were most likely to be reached -- 67 percent. Salomon Smith Barney took second place with 64 percent, followed by Merrill Lynch at 58 percent and Morgan Stanley at 57 percent. Goldman was last, at 49 percent.
A word of caution on these figures: this study was focused on one sector of the economy and based on data collected without the firms' help. The results could be quite different for research in other sectors.
Tuesday, October 16, 2007
Target Price Setting - A Method - Harry Domash
Don't buy a stock until you know its potential and set a target price.
A simple, 5-step process, using Oracle as an example.
By Harry Domash
Most money managers wouldn't consider buying a stock until they've set a target price, and neither should you.
Your target price is the price you think a stock will hit at a specified future date.
I'm going to describe a method that you can use to calculate target prices that is deceptively simple. It uses historical data rather than guidance from the companies themselves or Wall Street analysts. It involves forecasting a company's sales per share, and then using its historical price-to-sales ratios to set target stock prices.
To demonstrate the process, I'll compute a target price and tell you whether it's worth investing in software applications supplier Oracle
Why use sales and price-to-sales instead of earnings and price-to-earnings ratios? First, sales growth is easier to predict than earnings growth. Plus, if you look at historical data, you'll find that P/E ratios are a lot more volatile -- and thus, harder to forecast -- than P/S ratios.
Since the process is based on forecasts, and forecasts are always wrong, I won't try to set a precise target price. Instead, I'll estimate a low and high target-price range.
A five-step process
The stipulation is that the target-price date is always the day after a company reports its fiscal-year results. I call that fiscal year the target year.
Developing my target price consists of five steps:
• Estimate sales in the target year.
• Estimate the number of shares outstanding in the target year.
• Use the results from steps 1 and 2 to compute estimated target-year sales per share.
• Estimate expected range of price/sale ratios.
• Use No. 3 and No. 4 to compute the estimated target price range.
Now, we'll set a target for Oracle.
The company's fiscal year ends in May, so I'll use its 2007 fiscal year. Oracle will probably report its May 2007 fiscal year results in June or July 2007.
I've found that the calculations go faster if I first print MSN's key ratios 10-year summary and financial statements 10-year summary reports for stocks I analyze.
Step 1: Start with sales
Start by estimating a company's target fiscal-year sales. The 10-year financial statements summary shows each company's fiscal-year sales going back 10 years. Most analysts forecast sales growth in terms of year-over-year percentage increase. However, I've found that it's more useful to look at recent historical sales growth in terms of actual dollars instead of percentages.
Oracle's recent sales growth has been volatile, ranging from a $1.3 billion year-over-year gain in fiscal 2000 to a $1.2 billion drop in fiscal 2002. In its most recent fiscal year, ending in May 2004, sales climbed $681 million. I calculated Oracle's five-year average growth at $266 million, which isn't much compared to its $10.2 billion fiscal-year 2004 sales total.
Starting with Oracle's 2004 sales of $10.156 billion, I added $266 million to get $10.422 billion for 2005. Adding another $266 million results in $10.688 billion for its May 2006 fiscal year.
Finally, adding $266 million to that figure yields estimated sales of $10.954 billion for its May 2007 target year.
• Oracle target year sales: $10.954 billion
My sales estimate assumes that recent annual historical sales growth will continue. Obviously, that's not always the case. So modify your target-year sales if you have more reliable numbers.
Step 2: Shares outstanding
Next, I estimate a company's total shares outstanding at the end of its target year. Again, I use history as my guide. Many companies consistently increase their number of shares outstanding as they issue stock to raise cash, make acquisitions or allocate shares for employee stock options.
Oracle has reduced its number of shares outstanding in recent years. On average, its total dropped by 100 million shares annually over its past five fiscal years. Using that figure, I estimated that Oracle's average 5.2 billion shares outstanding in 2004 would drop to 4.9 billion by its fiscal 2007 target year.
• Oracle target year shares outstanding: 4.9 billion
Step 3: Sales per Share
Just as earnings per share is annual earnings divided by the number of shares outstanding, sales per share is annual sales divided by the number of shares out.
I estimated Oracle's target-year sales of $10.954 billion and shares outstanding at 4.9 billion. So my estimated target year sales per share ($10.954 divided by 4.9, rounded down) is $2.20.
• Oracle sales per share: $2.20
Step 4: Price/sales ratios
Investors frequently compare valuation ratios to evaluate the relative merits of companies in the same industry. For instance, Company A is the best buy if its P/E is only 20, while Company B's P/E is 35.
Competing firms often consistently trade at different valuations depending on their popularity with investors. For instance, pharmaceutical maker Pfizer (PFE, news, msgs) almost always trades at higher valuations than competitor Merck (MRK, news, msgs). This is true no matter what valuation ratio you choose. In terms of price/sales ratios, Pfizer's 6.6 average P/S over the past five years is almost double Merck's 3.5 figure. Similarly, chip maker Intel (INTC, news, msgs) has traded at an average 5.8 P/S over the past five years compared to 1.3 for competitor Advanced Micro Devices (AMD, news, msgs).
Thus, instead of comparing valuation to the overall market or to its sector, I've found that a stock's own history is the best indicator of its likely future trading ranges.
MSN's Key Ratios report shows the average annual price/sales ratios going back 10 years. I think the most recent five years' data are the most relevant, and that's what I use to determine the range of anticipated P/S ratios at my target date.
Over nine of the past 10 years, Oracle has traded at P/S ratios ranging from 4 to 7.9. However, in its May 2000 fiscal year, MSN lists its average P/S at 20. It's best to ignore an obviously out-of-range figure.
Disregarding the 2000 figure, Oracle's last five P/S ratios ranged from 4 to 7.9.
• Oracle target P/S: 4 to 7.9
Step 5: Doing the numbers
If you remember your algebra, you'll know that share price can be calculated by multiplying the sales per share by the price-to-sales ratio. For instance, a stock would be trading at $20 if its sales per share were $10, and the P/S ratio was 2 (it works: price/sales = 20/10 = 2).
Target Price = sales x P/S
In step 3, I estimated that Oracle would have sales of $2.20 per share. In step 4, I estimated its price/sales range at 4 to 7.9. Multiplying by sales per share by P/S:
• Oracle target price range: $8.80 to $17.40.
Oracle recently changed hands at $11.70; already within my $8.80 to $17.40 summer 2007 estimated trading range. I'd abandon Oracle for better prospects.
This simple target-price calculation is intended to help you evaluate stocks that you're researching. But it doesn't take changing economic or competitive conditions into account. In short, it's no substitute for doing your own due diligence.
Domash publishes the Winning Investing stock and mutual fund advisory newsletter and writes the online investing column for the San Francisco Chronicle. Harry has two investing books out, the most recent being "Fire Your Stock Analyst," published by Financial Times Prentice Hall.
Source: http://articles.moneycentral.msn.com/Investing/SimpleStrategies/FindStocksWithMoreProfitPotential.aspx
A simple, 5-step process, using Oracle as an example.
By Harry Domash
Most money managers wouldn't consider buying a stock until they've set a target price, and neither should you.
Your target price is the price you think a stock will hit at a specified future date.
I'm going to describe a method that you can use to calculate target prices that is deceptively simple. It uses historical data rather than guidance from the companies themselves or Wall Street analysts. It involves forecasting a company's sales per share, and then using its historical price-to-sales ratios to set target stock prices.
To demonstrate the process, I'll compute a target price and tell you whether it's worth investing in software applications supplier Oracle
Why use sales and price-to-sales instead of earnings and price-to-earnings ratios? First, sales growth is easier to predict than earnings growth. Plus, if you look at historical data, you'll find that P/E ratios are a lot more volatile -- and thus, harder to forecast -- than P/S ratios.
Since the process is based on forecasts, and forecasts are always wrong, I won't try to set a precise target price. Instead, I'll estimate a low and high target-price range.
A five-step process
The stipulation is that the target-price date is always the day after a company reports its fiscal-year results. I call that fiscal year the target year.
Developing my target price consists of five steps:
• Estimate sales in the target year.
• Estimate the number of shares outstanding in the target year.
• Use the results from steps 1 and 2 to compute estimated target-year sales per share.
• Estimate expected range of price/sale ratios.
• Use No. 3 and No. 4 to compute the estimated target price range.
Now, we'll set a target for Oracle.
The company's fiscal year ends in May, so I'll use its 2007 fiscal year. Oracle will probably report its May 2007 fiscal year results in June or July 2007.
I've found that the calculations go faster if I first print MSN's key ratios 10-year summary and financial statements 10-year summary reports for stocks I analyze.
Step 1: Start with sales
Start by estimating a company's target fiscal-year sales. The 10-year financial statements summary shows each company's fiscal-year sales going back 10 years. Most analysts forecast sales growth in terms of year-over-year percentage increase. However, I've found that it's more useful to look at recent historical sales growth in terms of actual dollars instead of percentages.
Oracle's recent sales growth has been volatile, ranging from a $1.3 billion year-over-year gain in fiscal 2000 to a $1.2 billion drop in fiscal 2002. In its most recent fiscal year, ending in May 2004, sales climbed $681 million. I calculated Oracle's five-year average growth at $266 million, which isn't much compared to its $10.2 billion fiscal-year 2004 sales total.
Starting with Oracle's 2004 sales of $10.156 billion, I added $266 million to get $10.422 billion for 2005. Adding another $266 million results in $10.688 billion for its May 2006 fiscal year.
Finally, adding $266 million to that figure yields estimated sales of $10.954 billion for its May 2007 target year.
• Oracle target year sales: $10.954 billion
My sales estimate assumes that recent annual historical sales growth will continue. Obviously, that's not always the case. So modify your target-year sales if you have more reliable numbers.
Step 2: Shares outstanding
Next, I estimate a company's total shares outstanding at the end of its target year. Again, I use history as my guide. Many companies consistently increase their number of shares outstanding as they issue stock to raise cash, make acquisitions or allocate shares for employee stock options.
Oracle has reduced its number of shares outstanding in recent years. On average, its total dropped by 100 million shares annually over its past five fiscal years. Using that figure, I estimated that Oracle's average 5.2 billion shares outstanding in 2004 would drop to 4.9 billion by its fiscal 2007 target year.
• Oracle target year shares outstanding: 4.9 billion
Step 3: Sales per Share
Just as earnings per share is annual earnings divided by the number of shares outstanding, sales per share is annual sales divided by the number of shares out.
I estimated Oracle's target-year sales of $10.954 billion and shares outstanding at 4.9 billion. So my estimated target year sales per share ($10.954 divided by 4.9, rounded down) is $2.20.
• Oracle sales per share: $2.20
Step 4: Price/sales ratios
Investors frequently compare valuation ratios to evaluate the relative merits of companies in the same industry. For instance, Company A is the best buy if its P/E is only 20, while Company B's P/E is 35.
Competing firms often consistently trade at different valuations depending on their popularity with investors. For instance, pharmaceutical maker Pfizer (PFE, news, msgs) almost always trades at higher valuations than competitor Merck (MRK, news, msgs). This is true no matter what valuation ratio you choose. In terms of price/sales ratios, Pfizer's 6.6 average P/S over the past five years is almost double Merck's 3.5 figure. Similarly, chip maker Intel (INTC, news, msgs) has traded at an average 5.8 P/S over the past five years compared to 1.3 for competitor Advanced Micro Devices (AMD, news, msgs).
Thus, instead of comparing valuation to the overall market or to its sector, I've found that a stock's own history is the best indicator of its likely future trading ranges.
MSN's Key Ratios report shows the average annual price/sales ratios going back 10 years. I think the most recent five years' data are the most relevant, and that's what I use to determine the range of anticipated P/S ratios at my target date.
Over nine of the past 10 years, Oracle has traded at P/S ratios ranging from 4 to 7.9. However, in its May 2000 fiscal year, MSN lists its average P/S at 20. It's best to ignore an obviously out-of-range figure.
Disregarding the 2000 figure, Oracle's last five P/S ratios ranged from 4 to 7.9.
• Oracle target P/S: 4 to 7.9
Step 5: Doing the numbers
If you remember your algebra, you'll know that share price can be calculated by multiplying the sales per share by the price-to-sales ratio. For instance, a stock would be trading at $20 if its sales per share were $10, and the P/S ratio was 2 (it works: price/sales = 20/10 = 2).
Target Price = sales x P/S
In step 3, I estimated that Oracle would have sales of $2.20 per share. In step 4, I estimated its price/sales range at 4 to 7.9. Multiplying by sales per share by P/S:
• Oracle target price range: $8.80 to $17.40.
Oracle recently changed hands at $11.70; already within my $8.80 to $17.40 summer 2007 estimated trading range. I'd abandon Oracle for better prospects.
This simple target-price calculation is intended to help you evaluate stocks that you're researching. But it doesn't take changing economic or competitive conditions into account. In short, it's no substitute for doing your own due diligence.
Domash publishes the Winning Investing stock and mutual fund advisory newsletter and writes the online investing column for the San Francisco Chronicle. Harry has two investing books out, the most recent being "Fire Your Stock Analyst," published by Financial Times Prentice Hall.
Source: http://articles.moneycentral.msn.com/Investing/SimpleStrategies/FindStocksWithMoreProfitPotential.aspx
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