Should I buy this stock? Is it priced right? What is the target price?

Many investors pose the following questions to analysts, researchers and TV Channel experts:

1. What’s your view on this stock?
2. Should I hold on to this stock?
3. Is this a good price to buy?
4. What is the target price of this stock?
5. Should I exit this stock?

This article will answer all these questions and help you become a self-reliant and confident investor:

1. Consider investing when the price is lower than the intrinsic value

The intrinsic value of a company is its actual true value. Its market price can be higher or lower.

Obviously, you should consider investing in a stock only when its actual value is lower than its CMP.

Now here’s a tool that will help you figure out a company’s intrinsic value.

Here is the explanation of each field:

EPS (Rs): The expected Earnings Per Share for the current year

Near Term Growth Rate (%): This is based on industry estimates and you can play with different growth scenarios.

For how many years: This is your estimate. For how long do you expect the company to grow at the rate you specified in the fiels above.

Long Term Growth Levels Off to (%): Typically over the long term, growth winds down to lower than the treasury rate. For example, Infosys after growing for more than 21 years saw its growth tapering off to lower than 7% when the treasury rate, which is now at 7.4%. So your estimate of the long term growth rate should be lower than the treasury rate, which is represented by the last field (Discount) below.

Probability (%): What are the chances of your assumptions coming true? You can play with different probabilities.

Discount (%): This is the safe rate of interest you can expect from a reputed borrower. For example, GOI bonds fetch 7.4%, Vikas Patras fetch 7.5%, Bank FDs fetch 7%, Corporate NCDs fetch 8%. So you have a range to play around with.

As an example, I calculated the Intrinsic value of Gujarat Pipavav, here are my assumptions:

Expected EPS of Rs5 this  year, a 10% growth rate for 6 years, which tapers down to 7% thereafter.The treasury rate assumed is  8% (Corporate Bonds),and the probability of my assumptions coming true at 50%.

This pegs GPPL’s intrinsic value at 314 and the stock is available at 144.

Typically, one must consider an investment when the stock is about 50%-60% of Intrinsic Value. Though GPPL is available cheaper, it is still not a buy as you will learn in the second half of the article.

2. Learn how To value a loss making company

Many quality companies make losses because they keep investing in acquisitions or software development (in the case of IT companies). Such companies’ EPS is negative and the Intrinsic Value Calculator cannot be used to calculate its true value.

In such cases, you can figure out if the stock is valued right by checking the EV/EBITDA ratio (Enterprise Value (EV) to Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA)).

The EV a company’s market capitalization (+) debt  (-) cash.

A EV/EBITDA ratio of 10 and below is considered good. Beyond 12-15 the stock can be considered overvalued.

You can figure out any stock’s EV:EBITDA at the Stock Axis’ website.

In this example, I have measured AB Cap’s EV/EBITDA ratio which is below 8 and therefore the stock is valued at a decent price.

3. Find your company’s target price

There are many ways that set up a stock’s target price.

One method is to estimate current year EPS and multiply it by the industry or peer PE ratio.

Another method is to inflate the industry or peer PE by 130%-150% (depending on market buoyancy) and multiply it by current earnings.

Alternatively, you can use the calculator on this site – The Target Price Calculator.

Here is an example where I have calculated GPPL’s target price:

Though GPPL’s intrinsic value is 314, it’s target price is a mere 120 and it is available at 141. The Target Price Calculator clearly indicates that the stock is overpriced. This will change when it starts reporting better numbers, but for the time being it is an avoid.

4. Other factors

There are other factors that can upset the calculations above – some examples are insider news, someone taking stake in the company, the company hiving off assets to pay debt, favorable global trends, etc.

These are not accounted in the tools above. To factor these in, you must have your ear to the ground.

Summing up, these are all the tools you need to figure out if a stock is worth buying, and at what price, and what is its target. It will help you become a self-reliant and confident investor.