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
Price Target = Current Market Price * [(Current P/E) / (Forward P/E)]
There are two types of P/E used in the above formula, namely Current P/E and Forward P/EForward P/EForward PE ratio uses the forecasted earnings per share of the company over the next 12 months for calculating the price-earnings ratio. Forward PE ratio formula = Price per share/Projected earnings per share .
- Current P/E
This price-earnings ratioPrice-earnings RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. 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 earningsEstimated EarningsEarnings Estimate is the projection of earning of an entity for a given period. Future projects, cash flows, market conditions, and several other factors are considered in calculating this estimate. of the next twelve months are considered. 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 shareEarnings Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is. 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 determine whether it is a good deal to buy or sell the stock or not regarding 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 analyzes various factors affecting its price, its price earning ratio, and so on. They make use of price target to give opinions for different stock positions.
This article has been a guide to Price Target and its definition. Here we discuss an example of a price target along with its formula, advantages, disadvantages, and its differences from fair value. You may learn more about financing from the following articles –