By: La Papillion
For avid readers of my blog, you might have realised that I am undergoing a deconstruction process of my valuation techniques. Just yesterday, I was debunking my own way of using a bastardized version of DCF to calculate the intrinsic value. Mr.Investor could very well describe me.
It’s important to read about investing and it’s also very important to practice it by valuating listed companies. Only then will the things read be transferred from the RAM of your brains to the more permanent hardisk. For now, I’ll be deconstructing my PE ratio analysis.
We can use the PE ratio to derive the future price of a company, if we also know about the earnings in the future. To go about doing that, we just need to follow the steps below:
1. Assume an earnings growth rate. Project future earnings by applying the earnings growth rate to current earnings.
2. Assume a PE ratio. Then multiply the projected future earnings with this PE ratio, and we’ll get the future price.
For example, company A has earnings growth rate of 21.1% (CAGR over 4 years). For simplicity, we assume a earnings growth of 20%. FY07’s EPS is 5.6 cts per share. Thus, projected FY08’s EPS is 6.7 cts per share (5.6 x 1.2 = 6.7).
Here’s the historical PE ratio: