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P = E Times X
My continued analysis of COW (iShares Agriculture ETF) is long overdue. Previously, I provided a list of the companies which comprise 80 percent of the makeup of COW. I then mentioned the relationship between price and earnings, and how calculating the potential price of the companies in the ETF results in a price we can use for valuing the ETF, itself. I had written that Price = Earnings per share Times X.
How do we determine a value for X? Given the formula above, we can then restate it as X = Price divided by Earnings per share. X is what is known as the Price to Earnings Ratio, or P/E Ratio (Price divided by Earnings). I looked up each of the companies on the list, and determined what, historically, would, seem like a conservative P/E Ratio over the past number of years. You can see my findings in the chart above.
What we need to understand about the P/E Ratio is that it is directly correlated to the growth rate of the company. The faster the company is growing, the more people are willing to pay to take advantage of that growth. To a point. I then compared my estimated P/E Ratio to the growth rate for each company. The P/E Ratio should be anywhere from 1 to 2 times the company's growth rate. What you see above are the adjusted numbers. CF is the exception. The historical growth rate for CF is greater than the P/E Ratio I am using, but I am more comfortable using the lower number in that case.
The Earnings per share estimates I am using are the average consensus earnings for all the analysts who follow each company, which are closest to the end of the current year. Multiplying the P/E Ratio by those Earnings numbers, we get a target price for each of the companies.
So, what price did I come up with for COW, for the end of the year? I'll show you those calculations next time. Still with me? Questions?