Final year’s P/E ratio
The final step is to incorporate the market P/E with the relative P/E and then figure the final year’s price. We performed the previous two steps in order to be able to do this one. What you will do here is multiply the final year’s market P/E by the relative P/E. (You will multiply the final number from step 5 and the final number from step 6). Make sure that you use the FINAL year’s market P/E (calculated in step 5) and NOT the current one.
Just to break this down for you and show you what is happening…..
You are multiplying a current valuation with a future valuation. In step 6 we calculated the relative P/E of the stock using numbers with no projections. In step 5 we used projections. The theory behind this is that we are looking at the valuation of where the stock is valued now to where it could be valued in the future, relative to the market.
Five-year projected Market P/E = 20.22
Relative P/E = 0.95
Final-year P/E = 20.22 * 0.95 = 19.21
This number is the reason we performed the previous two steps. This is going to be used to calculate our final year’s price, which we are going to do in the second part of this step.
Final year’s price
As part of this step we are going to take the above P/E ratio that we just calculated and we are going to figure the price of the stock in the 4th year based on this P/E and EPS from step 4.
You will need the EPS for the final year that you calculated in step 4. In the example I used, year 4 EPS was 2.12. You also need the above final year P/E which came out to be 19.21.
For the calculation, you just have to multiply these two numbers together. This will give you the final year’s price before we take the discount factor into consideration (explained in the next step).
Final year P/E=19.21
Calculation: 2.12 * 19.21 = $40.73
I mentioned earlier that year 4 EPS is the most important. It is because it’s also used to calculate final year’s price, and so the most weight in this valuation goes to year 4 EPS.
Put this on the diagram and move to the next step.
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