Price Target Definition
Price Target in the context of stock markets, means the expected valuation of a stock in the coming future and the valuation may be done either by the stock analysts or by the investors themselves. For an investor, price target reflects the price at which he will be willing to buy or sell the stock at a particular period of time or mark an exit from their current position.
Price Target Formula
There are two types of P/E used in the above formula, namely Current P/E and Forward P/E.
- Current P/E
This price-earnings ratio uses the earnings for the past twelve months. Thus, the current market price is divided by the average earnings of the last twelve months.
- Forward P/E
In the Forward P/E ratio, the estimated earnings of the next twelve months are taken into consideration. As such, the ratio is calculated by dividing the market price by average estimated earnings of the next twelve months.
A stock of a company is trading at $80 currently. The current earnings per share are $2. However, the estimated earnings per share are $2.5.
- Current P/E = 80/2 = $40
- Forward P/E = 80/2.5 = $32
Calculation of Price Target
- = 80 * (40/32)
- = $100
Price Target vs Fair Value
A price target is an estimation of the price at which the investors are expected to buy or sell a particular stock. It doesn’t reflect the actual worth of the stock. It will be used by the investors to decide whether it will be appropriate to buy or sell the stock based on the current market price of the stock, or the investor can wait to take his position.
On the other hand, the fair value of a stock reflects the intrinsic value of the stock or actual worth of the stock in other words. It helps the investor to decide whether a stock is overvalued or undervalued. Based on this valuation, an investor can decide whether it is a good deal to buy or sell the stock or not, as regards to the current market price and fair value.
- Price target helps an investor to decide whether he should hold the stock in expectations of an increase in future price or he should sell the share as the share has reached its target already.
- It helps the investors to decide the right time to exit or enter the market.
- It is based on the estimates of the future price-earnings ratio which in turn means it depends on estimates of future earnings. It is difficult to predict future earnings accurately. Thus, the target price is subject to the limitation that the estimates may not be accurate and the actual price may turn out to be different than the target price, which in turn will affect the strategy of the investor.
- It involves expert prediction and thus an individual investor may not be able to do the calculations himself and will need to depend on market experts only.
It is a concept used by the market analysts who keep a watch on the stock of the company and analyze various factors affecting its price, its price earning ratio and so on. They make use of price target to give opinions for various stock positions.
This has been a guide to Price Target and its definition. Here we discuss an example of price target along with its formula, advantages, disadvantages and its differences from fair value. You may learn more about financing from the following articles –