Correctly estimating future price targets for stocks is both a science and a skill. It is also a notoriously frustrating thing to do since companies and the marketplace often present surprises. Estimate future stock prices using financial analysis, then compare your estimates with an analysis of the five-year and one-year price charts for that stock. Technical analysis often shows the mood of the marketplace regarding a stock long before the financial events of the company show up in the financial news. Although stock prices tend to follow a company's earnings performance, it is always wise to cross-check your estimates with technical analysis.
1. Check the price-earnings ratio history for the stock. Price-earnings ratios tend to rise and fall over a period of years, depending on the mood of the marketplace. In boom times, price-earnings ratios will be higher than in recessions. Take the stock's current price-earnings ratio and adjust it up or down according to your expectations for the economy and its historical performance during similar economic conditions.
2. Estimate the company's earnings for the period you are forecasting by listing the earnings reported each year for the prior five to ten years. Most stock analysts estimate future earnings by computing a yearly percentage earnings change and comparing that to the then-prevailing economy. Adjustments are made to the percentage change in earnings for the forecast period according to past history during similar economic conditions.
3. Estimate the number of shares that will be outstanding during the forecast period. Normally, the number of shares outstanding will not change significantly from the number currently outstanding, but hints regarding new issuance of shares or stock buy-backs can be found in financial news stories or in the company's recent quarterly and annual reports.
4. Divide your estimated earnings by the number of shares estimated to be outstanding to forecast the earnings-per-share ratio. Take the earnings-per-share and multiply it by the price-earnings ratio to forecast the price target.
- Always check the estimates of professional stock analysts that cover your chosen stock. While you may be an excellent researcher, stock analysts often have insights on the stock's performance that you do not have. If your estimates seem out of line with those of the professional analysts, go back and review your research for reasons why.
- Although stocks tend to trade according to their price-earnings ratios, the true mover of stock price is market perception. Many good companies, with strong earnings, trade well under their estimated target prices because their industries have lost appeal in the market. Never be married to your estimated price targets if you see they are not likely to prove correct.
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