How is target price of a stock calculated (see attached research report)

[Biker]

Hi everyone,

I'd like to know how is target price of a company calculated in equity research reports of brokers. For eg consider the following report on Infosys ...

http://www.megaupload.com/?d=K0VHF13P

I have good knowledge of finance so advanced level answers are also welcomed.

 

[fundamentalvalue]

Valuation actually means how much is this asset worth.

Now Valuations can be done in various ways but primarily can be categorized as:

1. Fundamental valuation - the comprehensive and market agnostic valuation
2. Relative valuation - quick way to estimate today's value

Fundamental valuation isdriven more by intrinsic valuation making financial projections. I have written about it on fundamentalvaluation.blogspot.com

Relative valuation is not getting into financial projections but comparing valuations of assets relative to each other. There is a big assumption underlying this methodology, that market is correctly valuing the assets. I did a post on relative valuation that takes example of P/E you may want to read it.

Now fundamental vauation doesn't assume anything about whethermkt is correctly priced. So if fundamentals remain same, assets fundamental value will remain same irrespective of how market is priced. For example, lets assume that you value IBM before the financial crisis using fundamental valuation and then again after financial crisis. I think its not a strong assumption, rather a fact, that little changed for IBM during last 7/8 mos as far as fundamentals are concerned. So your fundamental value should be *approx* same if you would have done 7 mos back and if you do today.

But, if you do a relative valuation, there is a huge diff? Why revisit the assumption underlying relative valuation. If market switches sentiments, all stocks valuation change because darlings may be ostracized by investors.
So relative valuations changes with times and doesn't imply how much is asset worth. Rather it tells you therelative mispricing that you can exploit to make profits. BUT again, few do it correctly, because ultimately relative valuation is also driven by intrinsic valuation.(See my other post on P/E)

Now how do you estimate financial params. Well , it depends whether you want to make corse granular assumptions like revenue growth, EBIT and total CAPEX. Or you want to estimate finer line items estimations like op-expense etc. Never ever go line items estimations. If you see any such thing in research report they are actually derived from first estimating coarse granular projections and then estimating line items from it. Because what at the end determine your valuation is the FCF=cash flow after all investment expenses.

If you want to delve more into finacial valuation and see how it is done I did satyam valuation and you may want to go through it.

http://fundamentalvaluation.blogspot.com/2009/09/intrinsic-valuation-of-mahindra-satyam.html

 

[Biker]

My dear friend, you seem to have read Damodaran well. And I think its because of him that most of the B-school guys are so hot on DDM valuation.

In reality nearly 95% of the equity research is done through relative valuation. DDM is used with relative while doing large scale research like M&A, Pvt Equity placements, etc. DDM has its own benefits, but the degree of assumptions one has to make is large. More input assumptions will only give more deviation. I will choose a model which might not be perfect but which would require less assumptions than a model which requires large assumptions.

Anyways, this debate can go on forever and is not the main purpose of this thread. Though I have made some progress about target price calculation, but am stuck with forecasting various financial parameters/trend analysis ... I have made another thread about it, but am yet see any replies on that.

 

[bunny]

My dear friend, you seem to have read Damodaran well. And I think its because of him that most of the B-school guys are so hot on DDM valuation.

In reality nearly 95% of the equity research is done through relative valuation. DDM is used with relative while doing large scale research like M&A, Pvt Equity placements, etc. DDM has its own benefits, but the degree of assumptions one has to make is large. More input assumptions will only give more deviation. I will choose a model which might not be perfect but which would require less assumptions than a model which requires large assumptions.

Anyways, this debate can go on forever and is not the main purpose of this thread. Though I have made some progress about target price calculation, but am stuck with forecasting various financial parameters/trend analysis ... I have made another thread about it, but am yet see any replies on that.

You may want to have a look at technical analysis instead of fundamental analysis.

 

[SavantGarde]

Hi Biker,

Here Is A Link That may Perhaps Take You A Bit Further In Your Quest

http://www.wessa.net/

Happy & Safer Analysis

SavantGarde

My dear friend, you seem to have read Damodaran well. And I think its because of him that most of the B-school guys are so hot on DDM valuation.

In reality nearly 95% of the equity research is done through relative valuation. DDM is used with relative while doing large scale research like M&A, Pvt Equity placements, etc. DDM has its own benefits, but the degree of assumptions one has to make is large. More input assumptions will only give more deviation. I will choose a model which might not be perfect but which would require less assumptions than a model which requires large assumptions.

Anyways, this debate can go on forever and is not the main purpose of this thread. Though I have made some progress about target price calculation, but am stuck with forecasting various financial parameters/trend analysis ... I have made another thread about it, but am yet see any replies on that.