World’s Simplest Stock Valuation Measure

Here’s the world simplest stock valuation measure:

Growth Rate/2 + 8 = PE Ratio

Let me emphasize that this is simply a quick-and-dirty valuation tool and it shouldn’t be used as a precise measure of a stock’s value. But when I’m first looking at a stock and want to see roughly how it’s priced, this is what I’ll use.

For example, let’s look at Pfizer ($PFE). Wall Street expects the company to earn $2.34 per share next year. They also see the company’s 5-year growth rate at 2.79%. If we take half the growth rate and add 8, that gives us a fair value P/E Ratio of 9.40. Multiplying that by the $2.34 estimate gives us a fair price for Pfizer of $21.98. The current price for Pfizer is $22.98, so it’s about fairly priced.

Let’s look at IBM ($IBM) which has a higher growth rate. Wall Street sees IBM earning $16.61 next year. They peg the five-year growth rate at 10.58%. Our formula gives us a fair value multiple of 13.29, and that multiplied by $16.61 works out to a value of $220.75. IBM is currently at $201.71.

I like to find stocks that are going for more than 30% below our fair value. As I said, that’s just one tool I use to find bargain stocks.

Posted by on May 10th, 2012 at 10:51 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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