Another look at (one of the) Valuation methods

Following up with Aug 19th post, I noticed that forward EPS could be more reliable then trailing EPS. Nway, following is one the email I sent to one of my colleague on finding fair value of an equity. Here is the example for HPQ which could be extended to any stock:-

First of all you need to find what is the minimum ROI (Return on Investment) you have to have to invest. Following is the calculation assuming that 15% is the bare minimum you would need.

FOR HPQ:
* on 10/17/2008 the price is: 40.73$/stock
* P/E = 12.60 (forward PE is 9.92 as per the http://finance.yahoo.com/q/ks?s=HPQ)
* EPS = $2.93 (current year) (http://finance.yahoo.com/q/ae?s=HPQ)
* EPS growth rate = 28.9 % (this is the conservative general growth estimate by WSJ.com we will use this conservative number).
If you look at paste few years’ actual EPS number then average is 38.83% but then there is on sharp rise in between. I took 2008 and 2009’s estimate numbers as well.
2009e: 4.10 ==>2 14%
2008e: 3.61 ==> 2 34%
2007: 2.68 ==> 2 23%
2006: 2.18 ==> 2 165%
2005: 0.82 ==> (-18%)
2004: 1.15==> 15%
2004: 0.83

* Dividend on earning = 0.32c for 3.23$ EPS so it will be 9.9% of EPS. http://finance.yahoo.com/q?s=hpq


So using TMV (Time Value of Money/ http://www.zenwealth.com/BusinessFinanceOnline/TVM/TVMCalculator.html) at current rate the 5Y earning will be 10.43$ (using 38.83% growth rate it would be 15.11$ )
At 10.43$ EPS the 9.9% dividend would be 1.033$. So total Earning at 5Y = 10.43+1.033=11.463$.

So at current P/E rate, using TVM after 5Y the price would be = (P/EPS) * (EPS) = 9.92 * 11.463 = 113.71$. So if this assumptions/stat holds true then to get 113.71$ with 15% growth the fair value should be 56.53$. The current price of 40.73 is below this number so HPQ could be attractive business to own with 15% gain expectations.

Remember, here I used only one (EPS) of the many yardsticks to measure the fair value. If any of this number changes our outcome would change. When I will get some free time I will try to automate this computation using excel sheet.