Q & A - Calculating Fair Price - 11/10/2006

Current Market Price is $ 26.53. NPAT: 7,900 M.

Hi, Meaghan. Thank you for submitting your question to Novice Investing. For stock with strong EPS growth here, it is more complicated than pure linear no-growth EPS. Assuming that the stock continues to earn $ 2.89 in EPS from year 1 onwards, here is how we get into the fair value of the share:

Inflation assumed: 3% per annum

10 yr bond: 4.58% (source: CNN Money)

Yield expected     : 3 % more than 10 year bond

Fair P/E value           : inverse of yield

: 1 divided by 7.58 % = 13.19

Fair Price at Year 1   : (P/E x EPS) + EPS earned on year 0

: (13.19 x $ 2.89) + $ 1.30 = 39.42

Fair Price now : FP year 1 * ( 100% - Inflation rate )

                                    : $ 39.42 * 0.97

While I realize that this is crude calculation. This is a good enough estimation if you are trying to invest 3-4 years down the road. The really big assumption here is the EPS growth year 2 onwards. Generally, no company can produce 122.3% of EPS growth consistently year over year. Thus, this calculation shows a 0% growth in EPS after year one. Hope this one helps

END

Hmm, I am confused. And I have questions

I'm fine, thanks. Bring me back to main page

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