Target price

When is a stock considered cheap and when is it expensive? What is the intrinsic value of a company's stock?

When I first started out, I struggled with this concept. Many investors use different method of finding the intrinsic value. It is actually quite subjective and even Warren Buffett does not reveal how he arrives at the value of a company.

As retail investors, we love to find research reports where the target price is given. However we should beware of how the target price is arrived in most cases.

Most research analysts will give a target value based on the price-to-earnings ratio (PER) of a company. For example, the analyst takes the average PE ratio of the company over a period of time, say over 5 years. Then according to the predicted earnings (eps) at the end of FY13, for example, the target price is arrived. So if the average PE ratio is 15 and eps for FY13 is estimated to be $0.10, then the target price is 15 x $0.10 = $1.50.

We immediately see the potential problem here- the earnings estimate may be too optimistic. Or it may assume a blue sky scenario. If a black swan suddenly emerges, there will be a cut in the earnings estimate, and target price is reduced. You bought the stock last week with a potential 30% upside, suddenly new research report comes out and you are suddenly told that you should sell!

Rather than taking the average PE, some analyst may even take the PE at the high end. For example, if a stock's PE ranges from 12-18 in the past few years, the analyst may take a higher value of 16 or even 18.










Besides the average PER over time, the analyst may also take the average PER for the industry or sector (i.e. comparing with the company's peers). Then if the PER is less it peers' average, the company can be considered as lagging. However, we have to be aware the stock's PER may be comparatively low for some reason, which sometimes is difficult for retail investors to know. It  may be the company has smaller capitalization or less liquidity. Thus it is given a discounted PER.

Most retail investors wouldn't know the range of PE for a stock over the past 5 years. This is something I would like to see in research reports i.e. a graph showing the band of PE. So far I have only found this in RHB's research reports. KLSETracker/EquitiesTracker (available through online broking portals) does provide year end PER data and that is the best that I can find so far.