COW (part 2)

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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.

P/E Ratio
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.

Growth Rate
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.

Target Price
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?

Buy Agriculture Now?

Yes, COW
I am not a financial professional, and cannot recommend equities for you to buy.  Having said that, I want to share my analysis with you.  I do this as a means of teaching others a (relatively) simple approach to arriving at price targets.  Why agriculture?  This is a seasonally strong period of the year for agriculture stocks.  Second, my calculations  indicate there is as much as a 24 percent upside to the Exchange Traded Fund (ETF) with the ticker symbol COW on the TSX as at Saturday, Sept. 22.  I will provide additional details of my calculations over the next few posts, but first, a little more about COW.

Diversification
iShares lists the top holdings in COW by weighting.  By adding the weightings, we can see the top 13 companies make up 81 percent of the fund.  These companies are headquartered in Canada, the U.S., Chile, Brazil, Japan, and Switzerland.  As in this case, ETF's give me the most diversification at the cheapest price.  I could go out and buy each of the 13 companies (or only the one's I like), but the cost of the commissions to do so quickly adds up.

Price
Prices of ETF's such as this one follow an index.  As such, there is no fund manager deciding which company to buy, and when.  iShares manages the fund so it reflects the holdings in the index it is tracking.  The price follows that of the index because institutional providers package up the stocks of companies in the index to sell to iShares when it is cheaper to do so, and buy them back again when they become cheaper than the stocks. As a result, the constant buying and selling of ETF units causes the price of the ETF to mirror the index of stocks.  Price is a function of earnings.  At any given point, we can show the price of a share of stock as being the amount of company earnings divided by the number of shares multiplied by some number.  In other words, Price = Earnings/Share Times X.  Calculate the future price based on future earnings for most of the companies in an ETF, and we can compute the target price of the ETF.

Technical Analysis
Technical Analysis only goes so far when it comes to individual stocks.  That is doubly true of stocks which have a limited trading volume.  A volatile market such as the one we find ourselves in currently compounds the problem even more.  A price of a widely held ETF of widely held stocks is much more predictable than a single company.  The fundamental analysis I am in the process of sharing with you shows me what to buy.  I then use technical analysis to determine when to buy what I have calculated as having a cheap valuation relative to the current price.

Questions?  Comments?