Chapter 2 describes a common practice for determining a target price: Multiply an earnings forecast by an historical P/E multiple:
Target Price = Forecasted Earnings x P/E.
That target price is then taken as a value to compare with the traded price.
A recent paper dove into the text accompanying analysts’ stock recommendations and found, in a sample of 513 equity research reports, that most analysts use a trailing P/E to multiply their earnings forecast to get to an estimated price. They ask: “How would a firm with similar earnings have been priced last year?” The study found that trailing twelve-month P/E ratios account for 91% of the variation in analysts’ price targets.
See Ben-David, I. and A. Chinco. 2024. Expected EPS x Trailing P/E. At https://ssrn.com/abstract=4946881.
This is the “cheap value investing” of chapter 2. It compounds two problems. The chapter warns: In estimating price, do not put price into the calculation. And there is danger in basing a valuation on just one piece of information (earnings): Ignore Information at your peril.
A Google video points to tests of when analysts’ target prices are more reliable:
