How to find a stock's Right Price?
4.2.1. Valuation for a company
Let us understand how MoneyWorks4me arrives at the MRP and Discount price of a stock.
The Stock Price is the investment that we make per share. In return we can get money in two ways:
- Appreciation in the value of share
- 'Present Value of Future Dividends'- This is the income earned as Dividend during the holding period of a stock, discounted to its present value.
- 'Present Value of Future Price'- Expected stock price at the time of sale, discounted to its present value.
Considering our expected returns and inflation, MRP is the maximum price we should be willing to pay for the share today, which will grow in the future at our expected rate of return.
- To calculate MRP we need to know the Future Price and Present Value of Future Dividends. Future Price is calculated by the formula
- Thus to calculate the Future Price, we need to know the Future EPS. Future EPS can be estimated from the current EPS by using the compounding formula i.e.
Here, it is important to estimate the expected EPS growth rate of a company. At MoneyWorks4me, a team of experts analyse the company's past performance & future plan, market share, government policy, industry outlook, etc. In the end, after a thorough analysis, they come up with an expected EPS growth rate.
- The next step to calculate the Future Price is to find the Future PE. This is calculated by the team of experts at MoneyWorks4me through a thorough study of the historical trends of PE ratios as well as dividends. We have a special MoneyWorks4me method of calculating the future PE which we call 'Rational PE'. It depends on the inflation rate, expected EPS growth rate and expected rate of return.
- Now that we have done the first part, i.e. calculating the Future Price, we move to the second part in the calculation of MRP which is calculating the Present Value of Future Dividends. Here, the Future Dividends per Share are calculated by a team of experts from MoneyWorks4me and then are discounted at an appropriate rate of discount.
- Now that we know the Future Price and the Present Value of Future Dividend, we go on to calculate the MRP. The MRP, as discussed previously, is calculated on Present Value of Future Dividends and Present Value of Future price. Thus MRP is calculated by the formula
- Current EPS (which is known)
- Expected EPS Growth rate (which is calculated by the team of experts at MoneyWorks4me)
- Expected Rate of Return (which is calculated by the team of experts at MoneyWorks4me)
- Future PE Ratio (which is calculated by the team of experts at MoneyWorks4me)
- Present Value of Future Dividend per share (which is calculated by the team of experts at MoneyWorks4me)
- The research includes a thorough quantitative as well as qualitative stock analysis.
- The quantitative equity analysis includes scanning through historical data of each company. This is followed by a study of the future prospects of the company.
- The two combined together with our model based on Expected Earnings growth rate, Future P/E & dividend discounting helps us derive an MRP & Discount Price for each stock.