Question

You have found the following historical information for the Daniela Company:

	year 1	year 2	year 3	year 4
stock price	$46.48	$61.43	$65.39	$63.59
EPS	2.47	2.53	2.70	2.69

Earnings are expected to grow at 8 percent for the next year. Using the company's historical average PE as a benchmark, what is the target stock price in one year?

Answer 1

Step-1, Calculation of Average Price-Earnings Ratio (P/E Ratio)

Price-Earnings Ratio (P/E Ratio) = Current Stock Price / Earnings per share

P/E Ratio Year 1 = 18.82 Times [$46.48 / $2.47 per share]

P/E Ratio Year 2 = 24.28 Times [$61.43 / $2.53 per share]

P/E Ratio Year 3 = 24.22 Times [$65.39 / $2.70 per share]

P/E Ratio Year 4 = 23.64 Times [$63.59 / $2.69 per share]

Average Price-Earnings Ratio (P/E Ratio) = Total of P/E Ratio / 4 Years

= [18.82 + 24.28 + 24.22 + 23.64] / 4 Years

= 90.96 / 4 Years

= 22.7391 Times

Step-2, Calculation of Earnings per share (EPS) for the next year

Earnings per share (EPS) for the next year = EPS for the last year x (1 + Growth Rate)

= EPS4 x (1 + g)

= $2.69 per share x (1 + 0.08)

= $2.9052 per share

Step-3, Target Stock Price one year from today

Target Stock Price one year from today = EPS foe the next year x Average P/E Ratio

= $2.9058 per share x 22.7391 Times

= $66.06 per share

“Hence, the Target Stock Price one year from today will be $66.06”