For a screencast of this demo click here.
This exercise presents a step-by-step example of how to use Whitebox Research to calculate the Price Implied Expectations (PIE) for Google. We will demonstrate how to estimate what we believe the financial operating variables are that determine and justify Google’s stock price today and then demonstrate how to use the model to explore how different assumptions about those variables can change the PIE relative to Google’s stock price.
Looking at the PIE calculator module we have to enter a series of variables in order to calculate PIE:
We then click on calculate and the Price Implied Expectation is calculated at $437.46 which is pretty close to the current price of GOOG when we did this analysis.
The fun can now begin as we test these assumptions and see where GOOG can go, either up or down, based on how GOOG’s business changes and, in turn, how these variables may change. For example let’s say that we believe GOOG operating profit margin will stay at 29%. What does this mean for the implied price? Well if we go back to the PIE calculator and use the same variables as we just did but enter 29% instead of 21% for operating profit margin, the PIE comes out at $668.29. So if we really believe that there is opportunity for the operating margin to be that high, and we think the market doesn’t realized or appreciate that fact, the stock may be undervalued and could appreciate if the market realizes there is upside in GOOG’s operating margin resulting from underlying changes in its operations…for example higher margin service offerings.
Remember this model is just that, a model and it is only as good as the thinking that goes into it. While some of the financial variables will be “hard”, others will be left open to your thought process, assumptions and justifications. The variance that comes from this is encouraged as it will make the model richer.
Click on the link for more information and tutorials on calculating PIE: www.expectationsinvesting.com.