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Reviewed byDheeraj Vaidya, CFA, FRM
Price Target Definition
A price target in the context of stock markets means the expected valuation of a stock in the coming future. The valuation may be done either by the stock analysts or by the investors themselves. For an investor, a price target reflects the price at which he will be willing to buy or sell the stock at a particular period or mark an exit from their current position.
Table of contents
- Price Target Definition
- Price Target Formula
- Example
- Price Target vs Fair Value
- Advantages
- Disadvantages
- Conclusion
- Recommended Articles
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: 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 shareread more.
- 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. read more 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.read more for the next twelve months are considered. The ratio is calculated by dividing the market price by the average estimated earnings for the next twelve months.
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For eg:
Source: Price Target (wallstreetmojo.com)
Example
A stock of a company is trading at $80 currently. The current earnings per share are $2. However, the estimatedearnings 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.read moreare $2.5.
Solution
- 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 estimates the price at which the investors are expected to buy or sell a particular stock. It does not reflect the actual worth of the stock. The investors will use it to decide whether it will be appropriate to buy or sell the stock based on its current market price, or the investor can wait to take his position.
On the other hand, the fair value of a stock reflects the stock’s intrinsic value or actual worth of the stock, in other words. Therefore, it helps investors decide whether astock is overvaluedor undervalued. Furthermore, based on this valuation, an investor can determine whether it is a good deal to buy or sell the stock regarding the current market price and fair value.
Advantages
- Price target helps an investor decide whether he should hold the stock in expectation of an increase in future price or sell the share as it has already reached its target.
- It helps investors to decide the right time to exit or enter the market.
Disadvantages
- It is based on the estimates of the future price-to-earnings ratio, which in turn means it depends on future earnings estimates. Unfortunately, it is difficult to predict future earnings accurately. Thus, the target price is subject to the limitation that the forecast may not be accurate, and the actual price can be different from the target price, affecting the investor’s strategy.
- It involves expert prediction. Thus, an individual investor may not be able to do the calculations and will need to depend only on market experts.
Conclusion
It is a concept used by market analysts who watch the company’s stock and analyze various factors affecting its price, price-to-earnings ratio, etc. Then, they use price targets to give opinions on different stock positions.
Recommended Articles
This article is a guide to Price Target. We discuss price target definition, advantages, disadvantages, price target stock, and differences from a fair value. You may learn more about financing from the following articles: –
