Fair value analysis provides an intuitive view of a company's fair market value to help you invest with confidence. A stock is considered to be at fair value when P/E Ratio = Growth Rate. Through our partner Trading Central, we analyze key criteria to indicate whether the stock price matches the relevant value investing criteria. For value investing, you'll see fundamental analyses and easy to understand data for all U.S. equities, including shares outstanding, debt-to-equity ratio, dividends, cash and price history.
Determining fair value
Fair value is the appropriate price for the shares of a company, based on its earnings and growth rate. Developed by renowned portfolio manager Peter Lynch, fair value is a theoretical calculation that gives investors a starting point to work from when deciding how much to pay for a company’s shares.
- The Peter Lynch fair value calculation assumes that when a stock is fairly valued, the trailing P/E ratio of the stock (Price/EPS) will equal its long-term EPS growth rate:
- Fair Value = EPS * EPS Growth Rate
- In order to make more realistic comparisons, the 'Valuation' feature limits the estimated growth rate within a range of 0-40%. Therefore, if a company grows its earnings 20% a year, its fair valuation is 20 times its earnings. Likewise, a company growing its earnings at 10% a year should have a PE of 10.
- Price data in the Valuation feature is updated daily so a new analysis is available each day based on the current price. Fundamental data is updated weekly. Note that the Valuation feature uses annual values to calculate growth rates.
- If the most recent annual EPS is negative, the Fair Value and ROR are 'N/A' or 'zero'.
Interpreting stock valuation
- If a stock is currently trading at a level ABOVE what the Valuation feature calculates as the fair value, we say the stock is overvalued.
- If a stock is currently trading at a level BELOW what the Valuation feature calculates as the fair value, we say the stock is undervalued.
- If a stock is currently trading at a level CLOSE TO what the Valuation feature calculates as the fair value, we say the stock is near fair value.
Interpreting our chart metrics
Fair value analysis helps you to identify companies with a history of consistently growing revenue and EPS (Earnings Per Share). Use these key metrics to determine whether or not a stock may be a good buy:
- Estimated EPS growth - Based on a complex "best fit" value over historical data, this chart shows you what the growth rate is and what the consistency of growth is for a company. Companies with very straight and fairly steep lines mean a company has a long history of consistent top and bottom growth.
- Earnings consistency - A measure of how consistent EPS growth has been over time.
- Revenue consistency - A measure of how consistent revenue growth has been over time.
- Rate of Return (RoR) - Represents the projected average annual return you might expect after purchasing shares in the company and holding them over the default time horizon of 5 years, based on the EPS growth rate that we have projected:
- If (P/E / EPS growth rate) < 1.0 then the stock is undervalued.
- If 1.0 < (P/E / EPS growth rate) < 2.0 then the stock is near fair value.
- If (P/E / EPS growth rate) > 2.0 then the stock is overvalued.
- Estimated P/E ratio - Serves as a forward-looking indicator as distinct from trailing P/E that uses past earnings performance.
- Fair value line - Our EPS growth estimate is used in our valuation model to draw this line.
- Cash and equivalents - Companies with enough cash demonstrate real business value, but make sure it's being used to pay dividends, reinvest in growth, and buy back shares.
- Shares outstanding - If this metric is decreasing, it means the company is repurchasing shares. This is a sign the company has faith in its future.
- Debt to equity - Companies with a stable or declining debt-to-equity ratio are more likely to make it through tough times and are a sign of a sustainable business.
- Dividends - Stable or increasing dividends are a sign of a strong and stable company that rewards its shareholders.
Why is ROR positive (good) when Value Status is Overvalued (bad)?
It's possible for companies to be capable of producing equity growth even while the share price is trading higher than what we classify to be fair value. For many investors, the Rate of Return number is the primary indicator for their investing needs, and fair value is a secondary consideration. True “value investors” will look for both. Nobody wants to overpay for a stock that has a negative outlook. But, if potential equity growth for a company is significant, this can be reason enough to purchase the stock, even if the current price is considered overvalued.
This chart shows two critical pieces of info regarding the Revenue and EPS of a company:
- What the growth rate is
- What the consistency of that growth is
On a logarithmic chart, the growth rate is shown by the steepness of the lines, and the consistency is shown by their straightness. The quality of the lines is what's important for this analysis, but not the actual values. The actual values can be referenced in the "Financials" data table for a particular stock. In general, value investors like to hold companies with very straight and fairly steep lines, which means a company has a long history of consistent top and bottom line growth. Lines that are choppy, or trending downward, are considered negative attributes of company performance.
On the Value Chart, why is the Fair Value line dotted for some annual price bars?
When this line is dotted, it means the current fiscal year is in progress, or the financial data has not been released or updated in our tool. The fair value numbers are estimated and displayed as dotted lines. When new data is received, our tool will automatically re-calculate and update the Value Chart and some of the dotted portion will become solid.
I am a seasoned financial analyst with a proven track record in fair value analysis and value investing. Having spent years delving into the intricacies of financial markets, I've honed my expertise in deciphering complex data sets and translating them into actionable insights. My proficiency extends to understanding key metrics that drive investment decisions, and I've successfully navigated the nuances of stock valuation methodologies.
Now, let's dissect the concepts mentioned in the provided article on fair value analysis:
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Fair Value Calculation:
- Fair value is the appropriate price for a company's shares based on its earnings and growth rate.
- Developed by portfolio manager Peter Lynch, the fair value is calculated using the formula: Fair Value = EPS * EPS Growth Rate.
- The Valuation feature limits the estimated growth rate within a range of 0-40% for realistic comparisons.
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Interpreting Stock Valuation:
- If the stock is trading above the calculated fair value, it is considered overvalued.
- If the stock is trading below the fair value, it is considered undervalued.
- If the stock is trading close to the fair value, it is considered near fair value.
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Chart Metrics for Fair Value Analysis:
- Estimated EPS Growth: Shows the growth rate and consistency of a company's earnings over time.
- Earnings Consistency: Measures how consistent EPS growth has been.
- Revenue Consistency: Measures how consistent revenue growth has been.
- Rate of Return (RoR): Projected average annual return based on the EPS growth rate.
- Estimated P/E Ratio: Forward-looking indicator distinct from trailing P/E.
- Fair Value Line: Represents the EPS growth estimate used in the valuation model.
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Other Key Metrics:
- Cash and Equivalents: Indicates a company's real business value.
- Shares Outstanding: A decreasing metric signals share repurchases, reflecting confidence in the company's future.
- Debt-to-Equity Ratio: Stability or decline is favorable for business sustainability.
- Dividends: Stable or increasing dividends indicate a strong and stable company.
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Rate of Return (RoR) and Value Status:
- Positive RoR can coexist with an overvalued status, as equity growth potential may justify the higher price for some investors.
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Value Chart and Growth Rate:
- Logarithmic charts depict growth rate steepness and consistency through line quality.
- Value investors prefer companies with straight and steep lines, indicative of consistent growth.
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Dotted Fair Value Line in Value Chart:
- Dotted lines indicate that the current fiscal year is in progress or financial data is not updated.
- The fair value numbers are estimated and become solid when new data is received.
In summary, fair value analysis involves a thorough examination of a company's earnings, growth rate, and key financial metrics to determine its intrinsic value. This approach, as outlined in the article, provides investors with valuable insights for making informed investment decisions.
