Introduction
EACH COMPANY IS normally followed by several brokers who produce a range of reports and analysis. A survey of broker forecasts for company revenue, earnings and dividends over the next two years can be used to form a broker consensus on fair valuation and whether brokers collectively view the shares as cheap, fairly valued or expensive.
This chapter shows how to produce an estimate of the broker’s consensus price forecast for a company, based on their forecasts of the fundamentals. It then explains how to construct a price range that the shares are expected to trade in over the near term. This range is used to signal where brokers believe the current value lies.
Calculating broker valuations
Several different approaches can be employed to estimate the value brokers place on the shares of a company. This section discusses each of the individual methods in turn and then explains how to aggregate these forecasts into a single consensus price and a price range for assessing value.
Salesbased broker valuation method
The salesbased broker valuation estimates the consensus share price using brokers’ consensus forecasts of sales over the next two years.
Step 1: Calculate sales per share
Sales per share is sales revenue divided by the total number of shares outstanding. While historic sales per share is easily calculated, the forecast sales per share needs an estimate of the number of outstanding shares over the next two years. To estimate the number of shares outstanding in forecast years, you can either use the current number of shares (if the number of outstanding shares has been gradually decreasing) or you can assume that the number of shares outstanding grows at a similar pace to recent history. Forecast sales per share is then calculated by dividing the consensus broker forecast for sales by the estimate of the number of shares outstanding.
Example
Sales per share, including broker forecasts, for XP Power has already been calculated in chapter 4, table 4.2. Table 11.1 reproduces the sales per share calculation, for convenience.
Table 11.1 Sales per share (SPS) calculation – XP Power
2010 
2011 
2012 
2013 
2014 
2015 
2016 
2017 
2018 (f) 
2019 (f) 

Sales (£m) 
91.8 
103.6 
93.9 
101.1 
101.1 
109.7 
129.8 
166.8 
199.0 
212.8 
Shares Outstanding (m) 
19.0 
19.1 
19.1 
19.1 
19.2 
19.2 
19.2 
19.4 
19.6 
19.8 
Sales per Share (SPS) (p) 
483.2 
542.9 
492.8 
528.0 
526.7 
572.2 
677.4 
860.3 
1014.4 
1072.1 
(f) indicates broker forecasts, taken at December 2018.
Step 2: Calculate price to sales ratio (PSR) measures
The price to sales ratio (PSR) is price divided by sales per share. The highest and lowest PSR in each of the past five reported years can be calculated using the highest and lowest closing price and the reported sales per share in each year. The highest/lowest PSR for a year is calculated by dividing the highest/lowest price of the year by the reported sales per share.
The average high (or low) PSR over the past five years can be calculated as an average of these highest/lowest price to sales ratios. A central average PSR is calculated as an average of the highest and lowest PSRs over the past five years. (Note that this is equivalent to taking an average of the average highest PSR and the average lowest PSR.)
Example
Table 11.2 shows the calculation of the highest and lowest PSRs for XP Power, which is also calculated in chapter 4. The highest price to sales ratio in 2017 is calculated by dividing the highest closing price in 2017 (3626.4p) by sales per share in 2017 (860.3p), which gives 4.2. The lowest price to sales ratio in 2017 is calculated by dividing the lowest closing price in 2017 (1725p) by sales per share in 2017 (860.3p), which gives 2.2. The highest and lowest PSRs in other years are calculated in a similar way.
Table 11.2 Annual price to sales ratio ranges
2013 
2014 
2015 
2016 
2017 
Average 

High Price (p) 
1630.0 
1798.0 
1750.0 
1845.1 
3626.4 

Low Price (p) 
972.3 
1340.0 
1375.0 
1396.8 
1725.0 

Sales per Share (SPS) (p) 
528.0 
526.7 
572.2 
677.4 
860.3 

PSR low 
1.8 
2.5 
2.4 
2.1 
2.0 
2.2 
PSR high 
3.1 
3.4 
3.1 
2.7 
4.2 
3.3 
Over the past five years, the highest PSRs have averaged 3.3 and the lowest PSRs have averaged 2.2. The overall average PSR is 2.75 (= (2.2 + 3.3) ÷ 2). The highest PSR was 4.2 in 2017 and the lowest PSR occurred in 2013, when it touched 1.8. These statistics are summarised in table 11.3.
Table 11.3 Summary statistics – price to sales ratio
Low 
Average low 
Average 
Average high 
High 

Price to sales ratio (PSR) 
1.8 
2.2 
2.75 
3.3 
4.2 
Step 3: Produce consensus broker price
The consensus broker target price (based on sales) for a forecast year is calculated by multiplying the average PSR by the forecast sales per share.
Example
From table 11.1, the forecast sales per share is 1014.4p in 2018 and 1072.1p in 2019. The average PSR is 2.75. Thus the target price for the end of 2018 is 2789.6p (= 2.75 × 1014.4p) and the target price for the end of 2019 is 2948.3p (= 2.75 × 1072.1p).
Step 4: Produce valuation ranges
The valuation ranges are intended to act as a guide to whether the shares look expensive or cheap based on broker consensus and possible future market valuations.
The broker view is that the shares offer good value if the current share price is below the forecast sales per share multiplied by the average low PSR, and excellent value if the share price is below the forecast sales per share multiplied by the lowest PSR. (This assessment assumes you have carried out all the quality checks and are satisfied with the results; otherwise there could be some hidden problem that justifies a low valuation.) The shares are considered poor value if the current share price is above the average high PSR multiplied by the forecast sales per share, and expensive if the current share price is above the highest PSR multiplied by the forecast sales per share.
Example
In the case of XP Power, the average low PSR is 2.2 (see table 11.3) and the sales per share are forecast to be 1014.4p in 2018 and 1072.1p in 2019. Thus the broker view would consider the shares to be good value if the share price falls below 2231.7p (= 2.2 × 1014.4p) for 2018 and 2358.6p (= 2.2 × 1072.1p) for 2019.
The lowest PSR over the past five years is 1.8. The share would be considered excellent value if the share price falls below 1825.9p (= 1.8 × 1014.4p) for 2016 and 1929.8p (= 1.8 × 1072.1p) for 2017.
From table 11.3, the average high PSR is 3.3. Thus, if the price rose to 3347.5p (= 3.3 × 1014.4p) during 2018 or 3537.9p (= 3.3 × 1072.1p) in 2019 the broker view would be that the shares offer poor value.
The highest PSR over the past five years was 4.2. Consequently, if the share price rose above 4260.5p (= 4.2 × 1014.4p) in 2018 or 4502.8p (= 4.2 × 1072.1p) in 2019, the shares would be considered expensive.
The boundaries of the price ranges are summarised in table 11.4. Towards the end of December 2018 XP Power’s share price was 2130p. The shares are therefore considered to be good value based on consensus broker sales forecasts for 2018 and 2019. There is 38.4% upside to the end of 2019.
Table 11.4 Broker price ranges
Excellent value 
Good value 
Average 
Poor value 
Expensive 

2018 SPS: 1014.4p 
1825.9 
2231.7 
2789.6 
3347.5 
4260.5 
2019 SPS: 1072.1p 
1929.8 
2358.6 
2948.3 
3537.9 
4502.8 
Earningsbased broker valuation method
The earningsbased broker valuation method estimates the consensus share price using brokers’ consensus forecasts of earnings over the next two years.
Step 1: Collect earnings per share data
Normalised historic EPS data and two years of broker forecasts are readily available on Morningstar and Stockopedia websites.
Example
The normalised earnings per share for XP Power, including consensus broker forecasts, is shown in table 11.5.
Table 11.5 Normalised earnings per share (EPS)
2010 
2011 
2012 
2013 
2014 
2015 
2016 
2017 
2018 (f) 
2019 (f) 

Normalised EPS (p) 
83.20 
106.40 
81.30 
95.10 
101.10 
102.80 
111.20 
146.00 
176.0 
189.5 
(f) indicates broker forecasts, taken at December 2018.
Step 2: Calculation of price to earnings ratio (PE ratio) measures
The PE ratio is price divided by earnings per share. The highest and lowest PE ratio in each of the past five reported years are calculated by using the highest and lowest closing price and the reported EPS in each year. The highest/lowest PE ratio for a particular year is calculated by dividing the highest/lowest price of the year by the reported EPS.
The average high (or low) PE ratio over the past five years can be calculated as an average of these highest (or lowest) PE ratios. A central average PE ratio is calculated as an average of the highest and lowest PE ratios over the past five years.
Example
The highest and lowest closing price in each of the past five years is the same as in the salesbased method. The highest PE ratio in 2017 is calculated by dividing the highest closing price for XP Power’s shares in 2017 (3626.4p) by EPS in 2017 (146.0p), which gives 24.8.
The lowest PE ratio in 2017 is calculated by dividing the lowest closing price for XP Power’s shares in 2017 (1725.0p) by EPS in 2017 (146.0p), which gives 11.8. The highest and lowest PE ratios for other years are shown in table 11.6.
Table 11.6 Annual price to earnings ratio ranges
2013 
2014 
2015 
2016 
2017 
Average 

High Price (p) 
1630.0 
1798.0 
1750.0 
1845.1 
3626.4 

Low Price (p) 
972.3 
1340.0 
1375.0 
1396.8 
1725.0 

Normalised EPS (p) 
95.1 
101.1 
102.8 
111.2 
146.0 

PSR low 
10.2 
13.3 
13.4 
12.6 
11.8 
12.2 
PSR high 
17.1 
17.8 
17.0 
16.6 
24.8 
18.7 
Over the past five years, the high PE ratios have averaged 18.7 (= (17.1 + 17.8 + 17.0 + 16.6 + 24.8) ÷ 5) and the low PE ratios have averaged 12.2 (= (10.2 + 13.3 + 13.4 + 12.6 + 11.8) ÷ 5). The overall average PE ratio is 15.5 (= (12.2 + 18.5) ÷ 2).
The highest PE ratio over the five years was 24.8 in 2017 and the lowest PE ratio was 10.2 in 2013. These statistics are summarised in table 11.7.
Table 11.7 Summary statistics – price to earnings ratio
Low 
Average Low 
Average 
Average High 
High 

PE Ratio (p) 
10.2 
12.2 
15.5 
18.7 
24.8 
Step 3: Produce consensus broker price
The consensus broker target price (based on earnings) for a forecast year is calculated by multiplying the average PE ratio by the forecast earnings per share.
Example
From table 11.5, forecast earnings per share is 176.0p in 2018 and 189.5p in 2019. The average PE ratio is 15.5. Thus, the target price for the end of 2018 is 2719.2p (= 15.5 × 176.0p) and for the end of 2019 is 2927.8p (= 15.5 × 189.5p).
Towards the end of December 2018 XP Power’s share price was 2130p, which suggests that the company is trading 21.7% below broker valuation for 2018 and 27.2% below the broker valuation for 2019.
Step 4: Produce broker valuation ranges
The valuation ranges are intended as a guide to determine whether the shares look expensive or cheap based on broker earnings consensus and future market valuations.
The broker view is that the shares offer good value if the current share price is below the forecast EPS multiplied by the average low PE ratio, and excellent value if the share price is below the forecast EPS multiplied by the lowest PE ratio. If the current share price is above the average high PE ratio multiplied by the forecast EPS, the broker view is that the shares are poor value. The shares are expensive if the share price is above the highest PE ratio multiplied by the forecast EPS.
Example
In the case of XP Power, the average low PE ratio is 12.2 (see table 11.7) and EPS is forecast to be 176.0p in 2018 and 189.5p in 2019. Thus, the consensus broker view would consider the shares to be good value if the share price falls below 2147.2p (= 12.2 × 176.0p) for 2018 and 2311.9p (= 12.2 × 189.5p) for 2019.
The lowest PE ratio over the past five years is 10.2. The share would be considered excellent value if the share price falls below 1795.2p (= 10.2 × 176.0p) for 2018 and 1932.9p (= 10.2 × 189.5p) for 2019.
From table 11.7, the average high PE ratio is 18.7. Thus, if the price is above 3291.2p (= 18.7 × 176.0p) during 2018 or 3543.7p (= 18.7 × 189.5p) in 2019 the broker view is that the shares offer poor value. The broker valuation ranges for 2018 and 2019 are summarised in table 11.8.
Towards the end of December 2018 XP Power’s share price was 2130p. Broker valuations based on earnings forecasts currently suggest that the share price is good value based on consensus earnings forecasts for 2018 and 2019.
Table 11.8 Broker valuation ranges
Excellent value 
Good value 
Average 
Poor value 
Expensive 

2018 EPS: 176.0p 
1795.2 
2147.2 
2719.2 
3291.2 
4364.8 
2019 EPS: 189.5p 
1932.9 
2311.9 
2927.8 
3543.7 
4699.6 
Broker target price: Hybrid salesearningsbased broker valuation method
The hybrid salesearnings valuation method combines broker views on future sales with information on net profit margins and the number of shares outstanding to estimate future earnings and place a value on the shares of a company.
Step 1: Obtain future sales forecasts
Broker consensus sales forecasts for the next two accounting years are the starting point of the hybrid valuation method.
Example
XP Power’s broker sales forecasts towards the end of December 2018 were for sales to rise from £166.8m in 2017 to £199m in 2018 and to £212.8m in 2019.
Step 2: Estimate the average net profit margin
Profit margin is net earnings divided by sales. Equivalently, profit margin can be defined as the price to sales ratio divided by the price to earnings ratio.
To estimate the average longterm profit margin, the average PSR (calculated in step 2 of the salesbased broker valuation method) is divided by the average PE ratio (calculated in step 2 of the earningsbased broker valuation method).
Example
Table 11.3 shows that the average PSR is 2.75, while table 11.7 shows the average PE ratio is 15.5 for XP Power. Thus, the average profit margin is 17.8% (= 2.75 ÷ 15.5).
Step 3: Estimate future net earnings over the next two years
Net earnings for a year in the future are obtained by multiplying the longterm profit margin against future sales in that year. Thus, net earnings for the next accounting year are calculated by multiplying the average profit margin by the next accounting years’ sales. Similarly, net earnings for the second year are the average net profit margin multiplied by the broker forecast of sales in two years’ time.
Example
XP Power’s sales are forecast to be £199m in 2018 and £212.8m in 2019. Thus, net earnings are estimated to be £35.4m (= 17.8% × £199m) in 2018 and £37.9m (= 17.8% × £212.8m) in 2019.
Step 4: Estimate outstanding shares in future years
The annual growth rate of outstanding shares over the past five years is calculated in the same way as the salesbased broker valuation method.
Example
The number of shares outstanding has already been estimated for XP Power in table 11.1. It is assumed that there are 19.6m shares outstanding in 2018 and 19.8m shares in 2019.
Step 5: Calculate future earnings per share
Forecast EPS is calculated by dividing forecast net earnings by the forecast number of outstanding shares.
Example
Table 11.9 shows the calculation of forecast EPS over the next two years. EPS for the reporting year 2018 is 180.6p (= (35.4 ÷ 19.6) × 100) and is estimated to be 191.4p in 2019. (Here we multiply by 100 to convert from pounds to pence.)
Table 11.9 Earnings per share (EPS) calculation incorporating additional information
Forecasts 

2018 
2019 

Net earnings (£m) 
35.4 
37.9 
Shares outstanding (m) 
19.6 
19.8 
EPS (p) 
180.6 
191.4 
Broker forecasts at December 2018.
Note that the consensus broker forecasts for normalised EPS are not being used in this method. Instead, the broker forecasts for future sales are being used in combination with estimates of the longterm profit margin and the number of shares outstanding to produce an alternative estimate of EPS.
Step 6: Calculate the price to earnings ratio ranges
Calculation of the PE ratio ranges follow the methodology used in step 2 of the earningsbased broker valuation method. The highest and lowest PE ratio in each of the past five reported years are calculated using the highest/lowest closing price and the reported EPS. The highest or lowest PE ratio for a year is calculated by dividing the highest/lowest price of the year by the reported earnings per share.
The average high (or low) PE ratio over the past five years is calculated as an average of these highest/lowest price to earnings ratios. A central average PE ratio is calculated as an average of the highest and lowest PE ratios over the past five years.
Example
The historic highest and lowest PE ratios in each year for XP Power are calculated in table 11.6. The PE ratio summary statistics are shown in table 11.7. For convenience, the statistics are replicated in table 11.10.
Table 11.10 Summary statistics – price to earnings ratio
Low 
Average low 
Average 
Average high 
High 

PE ratio (p) 
10.2 
12.2 
15.5 
18.7 
24.8 
Step 7: Calculate the consensus broker price forecast
The consensus broker target price for a forecast year is calculated by multiplying the average PE ratio by the forecast EPS.
Example
From table 11.9, the forecast EPS is 180.6p in 2018 and 191.4p in 2019. The average PE ratio is 15.5. Thus, the target price for the end of 2018 is 2790.3p (= 15.5 × 180.6p) and the target price for the end of 2019 is 2957.1p (= 15.5 × 191.4p).
Towards the end of December 2018 XP Power’s share price was 2130p, which suggests that the company is trading below broker valuation for 2018 and 2019.
Step 8: Produce broker valuation ranges
The valuation ranges are intended as a guide to determine whether the shares look expensive or cheap based on broker consensus and possible future market valuations.
The broker view is that the shares offer good value if the current share price is below the forecast EPS multiplied by the average low PE ratio, and excellent value if the share price is below the forecast EPS multiplied by the lowest PE ratio.
The broker view is that the shares are poor value if the current share price is above the average high PE ratio multiplied by the forecast EPS, and expensive if the current share price is above the highest PE ratio multiplied by the forecast EPS.
Example
In the case of XP Power, the average low PE ratio is 12.2 (see table 11.10) and EPS is forecast to be 180.6p in 2018 and 191.4p in 2019. Thus, the consensus broker view is that the shares are good value if the share price is below 2203.3p (= 12.2 × 180.6p) for 2018 and 2335.1p (= 12.2 × 191.4p) for 2019.
The lowest PE ratio over the past four years was 10.2. Thus, the shares would be considered excellent value if the share price falls below 1842.1p (= 10.2 × 180.6p) for 2016 and 1952.3p (= 10.2 × 191.4p) for 2017.
From table 11.10, the average high PE ratio is 18.7. Thus, if the price is above 3377.2p (= 18.7 × 180.6p) during 2018 or 3579.2p (= 18.7 × 191.4p) in 2019 the broker view would be that the shares offer poor value.
The highest PE ratio over the past four years was 24.8. Consequently, if the share price rose above 4478.9p (= 24.8 × 180.6p) in 2018 or 4746.7p (= 24.8 × 191.4p) in 2019, the shares would be considered expensive.
Towards the end of December 2018 XP Power’s share price was 2130p. Broker valuations based on hybrid forecasts currently suggest that the share price is good value for 2018 and 2019. The boundaries of the price ranges are summarised in table 11.11.
Table 11.11 Broker price target ranges
Excellent value 
Good value 
Average 
Poor value 
Expensive 

2018 EPS: 180.6p 
1842.1 
2203.3 
2790.3 
3377.2 
4478.9 
2019 EPS: 191.4p 
1952.3 
2335.1 
2957.1 
3579.2 
4746.7 
Producing a consensus broker valuation
In the examples above, the broker valuation methods can sometimes give different conclusions. In general, you would like at least two of the three methods to suggest that the company offers good value. To produce an overall broker consensus, you can either take the average value of the ranges or choose the method which has the closest (average) fair value price.
Example
Table 11.12 summarises the broker valuations for the different approaches. The consensus is obtained by finding the average value in each column of the table. The consensus broker fair value price is 2766.4p.
Towards the end of December 2018 the share price was 2130p, meaning that the overall broker consensus is that the shares offer good value. XP Power’s shares would be excellent value if the price fell below 1821.1p and poor value if the price rises above 3338.6p a share.
Table 11.12 Composite consensus broker valuation – end 2018 forecast
Excellent value 
Good value 
Average 
Poor value 
Expensive 

Sales 
1825.9 
2231.7 
2789.6 
3347.5 
4260.5 
Earnings 
1795.2 
2147.2 
2719.2 
3291.2 
4364.8 
Hybrid 
1842.1 
2203.3 
2790.3 
3377.2 
4478.9 
Average 
1821.1 
2194.1 
2766.4 
3338.6 
4368.1 
Table 11.13 shows a similar approach using the end 2019 forecast. This is arguably more relevant given the analysis is being undertaken towards the end of December 2018. The consensus broker fair value price is 2944.4p for the end of 2019.
Table 11.13 Composite consensus broker valuation – end 2019 forecast
Excellent value 
Good value 
Average 
Poor value 
Expensive 

Sales 
1929.8 
2358.6 
2948.3 
3537.9 
4502.8 
Earnings 
1932.9 
2311.9 
2927.8 
3543.7 
4699.6 
Hybrid 
1952.3 
2335.1 
2957.1 
3579.2 
4746.7 
Average 
1938.3 
2335.2 
2944.4 
3553.6 
4649.7 
The overall broker consensus can be used to infer the margin of safety believed to be in the market by brokers. This margin is the percentage increase required in the current price to return to the overall broker consensus of fair value. (If the percentage change is negative there is currently no margin of safety.)
Example
The current share price for XP Power is 2130p. Based on the 2018 broker fair value price of 2766.4p, there is a 23% (= (1 – 2130 ÷ 2766.4)) margin of safety. Similarly, based on the 2019 broker fair value price of 2944.4p, the margin of safety widens to 27.7% (= (1 – 2130 ÷ 2944.4)). The consensus broker expectation is that there is a healthy margin of safety.
Summary
This chapter has shown how to make use of broker views on earnings and sales by translating them into a consensus view on the value of the shares using a range of approaches. The broker price ranges produced allow you to assess whether the current share price is considered fair, good value or expensive by the market (proxied by the consensus broker view) and estimate margin of safety. It also gives an idea of the potential risk to reward ratio if the shares are purchased at a certain price.