Question

I am not sure where, to begin with, this problem...

"You have found the following historical information for DEF Company:

                         Year1       Year 2        Year 3        Year 4

Stock Price        $46.29         $49.74          $54.55          $57.07

EPS                  $2.04 $2.9    $2.81    $3.78

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 = 22.69 Times [$46.29 / $2.04 per share]

P/E Ratio Year 2 = 17.15 Times [$49.74 / $2.90 per share]

P/E Ratio Year 3 = 19.41 Times [$54.55 / $2.81 per share]

P/E Ratio Year 4 = 15.10 Times [$57.07 / $3.78 per share]

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

= [22.69 + 17.15 + 19.41 + 15.10] / 4 Years

= 74.35 / 4 Years

= 18.5884 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)

= $3.78 per share x (1 + 0.08)

= $3.78 per share x 1.08

= $4.0824 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

= $4.0824 per share x 18.5884 Times

= $75.89 per share

“Therefore, the Target Stock Price one year from today will be $75.89 per share“