If you are tempted to make a quick investment on a company you haven’t researched deeply, please at least run these two quick valuations. They will help you to see very quickly if you are sitting in front of a good opportunity or a potential loss. I never recommend investing just by running these two valuations, but if you must at least they can help you identify opportunities and avoid costly mistakes.
Growth Rate vs PE Ratio Method
This is a rough method that can help you identify how cheap or expensive a stock might be. You need two numbers to apply this valuation: the next year’s earnings estimate and the 5-year earnings growth estimate. You can find this information easily at www.zacks.com.
Let’s look at this valuation by using a quick example, using this formula:
Growth Rate/2 + 8 = PE Ratio
Let’s look at Dell ($DELL). Wall Street expects the company to earn $2.05 per share next year. They also see the company’s 5-year growth rate at 2.6%.
If we take half the growth rate and add 8, that gives us a fair value P/E Ratio of 9.30. Multiplying that by the $2.05 estimate gives us a fair price for DELL of $19.06. The current price for DELL is $12.51, so it’s fairly priced, and we could assume DELL is 34.3% undervalued.
A Stock Value Relative to Treasury Bonds
All investments compete with one another, and the return on treasury bonds is the benchmark that all investments must ultimately compete with. To establish the value of the company relative to treasury bonds, divide the current per share earnings (TTM) by the current return on treasury bonds. In the case of $DELL, the current EPS (Trailing 12 Months) is $2.02. Divide that by the long-term government bond interest rate (10 Years), currently at 2.76%, (you can find that information easily at the treasury website.
Once you do this you get a relative value of $73.19 a share. The current price for DELL is $12.51 which means DELL could be a fairly good investment opportunity.