Lets look at Microsoft (MSFT) today.
This posting is open for discussion and to determine the entry and exit price points by using 3 different methods. These three methods use the historical P/E, CF/S and the dividend (D/S) ratios. Please note that there is a ton of ratios out there.
Definitions of the following terms used:
P/E. Price divided by its earnings, which shows what multiple that a investor is willing to pay for $1 dollar of earnings.
http://www.investopedia.com/terms/p/price-earningsratio.asp#axzz1ywxwNlkP
CF/S is the same as earnings except that its referring to the company’s ability to generate cash.
http://www.investopedia.com/terms/c/cashflowpershare.asp#axzz1ywxwNlkP
D/S or Dividend per share. For this ratio you would use the dividend yield formula.
http://www.investopedia.com/university/ratios/investment-valuation/ratio7.asp#axzz1ywxwNlkP
Using these historical ratios a person can estimate what the stock price range should be.
By comparing the 3 year average vs a longer term (10 year average or more) can also help to determine where the market believes the company is in its life cycle, which includes: start up (venture), growth or mature company.
Microsoft trades on the Nasdaq under the symbol (MSFT). MSFT has been a publicly traded company for more 10 years. MSFT is a computer software company and sells its products world wide.
So here we go: for the past 3 years MSFT has had an average P/E trading range of 14.53 (high) and 9.37 (low). Over a longer term MSFT has had average P/E ratio of 52.11(high) and 30.57(low) over the past 19 years. MSFT has also had some wild swings in the past with P/E values for example, in 2000 was at a high P/E ratio of 70.6 and a low P/E ratio 8.4 in 2011.
MSFT’s average annual Earnings growth of 19.51% over the past 6 years and 27.38% over a 14 year period. For the purposes of this analysis I am using the average of 19.51% increase to determine what MSFT should be valued at.
By estimating future earnings you can estimate the share price. In this case MSFT should earn about $3.20 in 2012 and using the average P/E the estimated trading range should be $46.52 (high) and $29.98 (low).
MSFT is a dividend payer which started in 2003. Over the past 3 years MSFT has increased its dividend by 12.53% annually, for the past 9 years MSFT has increased its dividend 39.25% compounded. Lets hope that the increases continue. MSFT’s dividend yield for the past 3 years ranged from 1.82 (high) to 2.8 (low). Currently MSFT is paying a 2.70% based on its current price $29.75. It is estimated that MSFT will increase its dividend to $0.67 per share in 2012.
Which makes the current price look attractive to buy.
Looking at the price per cash flow ratio (P/CF) MSFT has increased its CF/S with its 15 year CF/S ratio of 31.69 (high) and 18.77(low) however, the three year average gives a different picture. The current 3 year average is much better at 12.39 (high) and 8.0(low) Which gives MSFT a share price based on a cash flow of $54.57 (high) and $29.42 (low). With todays close of 29.75 is it appealing that its very near it’s estimated low price and a CF/S for 2012 of $3.68 per share. MSFT is closer to it’s low price based on its CF/S
Now on to, how to trade, as I’m looking to purchase shares of MSFT I would be writing a put near my price estimates in this case I’m looking to write a Put Option at $28 on the www.cboe.com So I’m looking to sell 10 June 2012 Put contracts for the 28 strike price and collect the premium of $.30 /share.
If your wondering on what the return would be? 28000 /300 = 1.07% at an annual rate of 12.86%
If you bought it today at the current price of $29.75 and wrote the call for one month June with the strike price of 30 dollars and a premium of $0.65 you would collect 65 dollars per contract for the premium and an additional $0.25 on the shares price increase. If MSFT was called away it would generate 3.02% for the month or 36.24% annualized. "Before fee’s"