• Gold price forecasts dependent on real gold price
• EPS and P/E ratios important indicators for calculation of share price
• Beware of overpriced assets
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Gold price is calculated from the inflation index and real gold price
Private investors are often faced with many questions regarding their investment behavior. As Patrick Herger from the “Neue Zürcher Zeitung” now reports, simple formulas can help investors to better understand price developments in shares and the price of gold. There are different factors between the two assets that investors should consider. The special feature of investing in gold is – especially in comparison to investing in shares – the generation of profit. While profit distributions by the companies concerned are possible in the case of shares, gold investors can only sell their holdings in order to make profits. How high this profit is depends on how much potential buyers are willing to pay for it. However, the price of gold can be calculated by multiplying an inflation index by the real price of gold. With the rise in the inflation index, a rise in the price of the precious metal is justified. Accordingly, according to Herger, if the price level increases by ten percent, the price of gold should also rise by ten percent.
Gold ETFs amplify price movements
In order to make forecasts for the price of gold, the real price of gold must be taken into account here. To get this, the price of gold is divided by the inflation index CPI. This calculation shows that the real gold price is currently similar to 1980 or 2011, according to Herger. In those years, investors expected strong inflation, which then failed to materialize and caused the price of gold to plummet. Herger explains the current high on the one hand with renewed expectations from investors that inflation will occur, but also with gold ETFs, which track the course of the gold price and have been responsible for the purchase of large amounts of gold in recent years. This has pushed the price of gold higher. Nevertheless, Herger warns that while gold ETFs amplify price movements in the price of gold, the lack of expectations of strong inflation could push the price of gold even lower than it has been in the past.
Earnings per share and price to earnings ratio
Herger also has formulas for calculating share prices. Two key figures are important here, namely earnings per share, also known as “earnings per share” or EPS for short, and the price-earnings ratio (P/E). EPS indicate what percentage of a company’s earnings goes to a single share. P/E is obtained by dividing a stock’s current price by its earnings per share. Conversely, if you multiply EPS and P/E, you get the stock price. Now there are two reasons for rising share prices: either the company’s earnings and thus earnings per share increase, but the P/E ratio remains the same, or earnings remain stable and the P/E ratio increases. Herger gives two examples to illustrate the formula. In the first case, he assumes a company that has a profit of 10 francs and a low PER of 10. This gives you a share price of 100 francs. With an annual, constant profit of 10 francs, the total profit of an investor corresponds to his investment after a period of ten years. In the second example, Herger names a company that also has earnings of CHF 10 per share, but has a P/E ratio of 30. Here the investment of an investor would only correspond to his profit after 30 years.
Consistent gains unlikely
However, it is very rare for a company to make profits that remain the same over the years, as Herger points out. Also, investors can accept a higher P/E if higher growth is expected. Herger explains a variation of his second example, in which the fictitious company has a rapidly growing profit and has already reached the purchase price of 300 francs ten years after the start of the investment. However, a long-term and reliable forecast of growth is not possible. Herger points to a study by economist Alex Coad from the Paris Center d’Economie de la Sorbonne, which states that a company’s growth over the long term is determined by chance. Furthermore, a reliable forecast is made more difficult by optimistic and often overestimated valuations on the markets. Therefore, cautious investors are more likely to look to stocks that are increasing in price due to earnings growth, not higher P/E ratios.
While the inflation index is a factor for an increase in the price of gold, earnings are driving prices higher for shares. The P/E serves as an indicator for the optimistic attitude on the markets. Still, both a high real gold price and a high price-to-earnings ratio should set alarm bells ringing for investors as it could be a warning sign that assets are overpriced. So-called buy-and-hold investors are currently exposed to an increased risk of not achieving price targets in the long term.
Editorial office finanzen.net
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