In this article, we revisit our pricing model for the evolution of Prudential Financial (NYSE: PRU) stocks presented in March 2012. Prudential is a company from the financial sector which provides various financial products and services. In March, we used the monthly closing prices between July 2003 and February 2012. PRU's share was at about $57 with the predicted level of $44.
The tentative model also predicted the price would grow in the first half of 2012 to $52. Therefore, we foresaw a negative correction in March-April. The actual price started to fall in the beginning of May and the monthly closing price for May was at the level of $45 per share. The updated model, as obtained with new data between March and October 2012, predicts a healthy growth in the price in 2012Q4. In January 2013, the price may reach the level of $64. On November 20, the closing price was $50.78. There is some potential of a 10% to 15% return at a three month horizon. One may consider PRU as an investment idea at this horizon.
The model has been obtained using our concept of share pricing as a decomposition of a share price into a weighted sum of two consumer price indices. The intuition is clear - there is a set of goods and services which any company produces and this set defines the share price evolution of a given company relative to other companies.
These other companies are also driven by prices for some goods and services. Hence, for a given company one needs two defining sets of goods and services to estimate its relative pricing power - one related and one as an independent reference. Thus, the relevant stock price can be defined by two CPIs which include corresponding goods and services.
Many SA readers have reasonable doubts that some consumer price, which is not directly related to goods and services produced by a given company, may affect its price. We allow the economy to be a more complex system than described by a number of simple linear relations between share prices and goods. The connection between a firm and its products may be better expressed by goods and services which the company does not produce or provide. The demand/supply balance is fragile and may evolve along many nonlinear paths. It would be too simplistic to directly define a company price only by its own products.
Originally, we addressed the PRU model in 2009 and found two CPIs explaining the monthly closing prices of PRU since 2003. They were the consumer price index of food and beverages (F) and the index of transportation services (TS). The defining time lags were as follows: the food index led the share price by 5 months and the TS index led by 4 months:
PRU(t) = -6.09F(t-5) - 3.15TS(t-4) + 59.76(t-1990) + 930.50, September 2009
In 2010 and 2012, we revisited the original model and estimated new coefficients and lags. These estimates were close to the original ones:
PRU(t) = -5.45F(t-5) - 3.98TS(t-3) + 59.66(t-1990) + 1055.38, September 2010
PRU(t) = -5.14F(t-5) - 3.80TS(t-4) + 56.20(t-1990) + 1005.63, February 2012
Here we revisit the model. We have borrowed the time series of monthly closing prices of PRU from Yahoo.com and the relevant (seasonally not adjusted) CPI estimates through October 2012 are published by the BLS. The best-fit model for PRU(t) is as follows:
PRU(t) = -5.09F(t-5) - 3.67TS(t-3) + 55.44(t-2000) + 1531.31, October 2012
where PRU(t) is the PRU share price in U.S. dollars, t is calendar time. One can conclude that the model has not been changing since January 2009 and thus provides a good estimate of the price at a three month horizon.
Figure 1 displays the evolution of both defining indices since 2002. Figure 2 depicts the high and low monthly prices for a share together with the predicted and measured monthly closing prices (adjusted for dividends and splits). The predicted prices are well within the limits of the high/low share price which might be considered as the actual price uncertainty.
The model residual error is shown in Figure 3 with the standard deviation between July 2003 and October 2012 of $6.01 ($5.58 in March 2012).
Figure 1. The evolution of F and TS indices
Figure 2. Observed and predicted PRU share prices.
Figure 3. The model standard error is $6.01.
Disclosure: I am long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.