The present value, or PV, of an expected stock price is the amount you would realistically pay today if you expect the stock price to reach a certain level tomorrow. These calculations are used often by businesses and economists to compare cash flow at different times. You can calculate this amount using a basic financial formula for present value of a future amount.
In order to calculate the PV of an expected stock price, you can use a simple mathematical formula which incorporates any expected dividends, the expected stock price, the number of years in the future you are representing and the estimated real rate of return.
Understanding Present Value
Present value, also known as the "discounted value," tells you what a stock is worth on the day you bought it. If you purchased shares in a company for $20 a share today, the present value is $20 a share. If you planned to put $20 a share into that same stock in a year, you can't call that the present value, since you can't know for sure that the stock will be worth $20 a share. But if you want to buy that stock a year from now and determine what its value will be at that time, also known as its "future value," you would first need to understand what it is worth today, then use a calculation to determine what it will be worth in a year.
Finding the Rate of Return
Determine the expected annual rate of return for the type of stock you’re investing in. To do so, research historical rate of return data for similar stocks, or a major stock market indicator like the average historical rate of return for the S&P 500. You can sometimes find this information listed in the annual reports of public companies and respected financial publications. Assume for the purpose of an example that the expected rate of return is 7.5 percent.
Subtract the estimated inflation rate for the period, which is also available by reviewing financial publications, to determine the real rate of return. For instance, if inflation is 2.5 percent, the real rate of return is 5 percent.
Determining the Future Value
Use a simple formula to determine the present value of the stock price. The formula is D+E/(1+R)^Y where D is any dividends expected to be paid during the period, E is the expected stock price, Y is the number of years down the line, and R is the real rate of return you estimated.
Plug the numbers into the formula to complete your calculation. For example, if your expected stock price is $58 per share one year in the future, total dividends paid during the period equal $2 per share with a real rate of return of 5 percent. The present value is $2 + $58/(1+.05)^1 or $57.14.
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