In this article, we introduce a tentative pricing model for TECO Energy (NYSE: TE). This is one of many energy related companies in the S&P 500 index. Our pricing model is based on our concept of stock dependence on the consumer price index. The intuition is simple and clear. We assume that the evolution of a share price is inherently related to the pricing power of goods and services it produces. Therefore, the evolution of the share price may be driven by the prices of these goods and services. For example, it is not easy to ignore the intuition that crude oil has to affect share prices of oil companies. We have reported that such a link exists for ConocoPhillips and formulated an empirical model. On the other hand, the oil price is not the only changing price and other goods and services should obviously affect share prices of oil companies. Thus one needs some reference price, which best expresses the overall price evolution. An example from life, when one jumps in a moving elevator the net trajectory depends on both the person and elevator.
Therefore, our model is seeking two CPI components from a large number of pre-selected ones, which minimize the difference between observed (monthly closing price adjusted for dividends and splits) and predicted prices for the period between July 2003 and October 2012. For TE, we use a set of 92 individual consumer price indices to select the best two CPIs in order to describe the evolution of the share price. Our two-component model also includes a free term (constant) and a linear time term, which compensates well know linear (time) trends between various CPI components. We allow the modeled share price to lead and lag behind one or both defining CPIs. When the price is lagged, the model is deterministic and foresees at the horizon of the smallest lag. When the price leads both CPIs, one cannot predict the future of the price but get some information on the future CPIs. In the case of TE, both CPIs are contemporary to the share price and the best-fit model is as follows:
TE(t)= -1.43R(t-0) + 0.05E(t-0) + 1.49(t-2000) + 150.92, October 2012
where R(t) in the index recreation at time t, E is the index of energy also contemporary to the price, (t-2000) is the elapsed time.
Figure 1 depicts the evolution of both CPIs. The index of recreation evolves slowly and the energy index has been actually driving the TE price since 2003. Figure 2 depicts the observed and predicted (monthly closing) prices together with the monthly high/low prices, which are natural limits of the inter-month price uncertainty. Our model correctly predicted the price since 2003. The model residual error is shown in Figure 3. It has standard deviation of $0.85 for the period between July 2003 and October 2012.
For an investor, the evolution of TE is almost fully related to the price index of energy. Our model of oil price evolution implies a fall to $40 to $60 by 2016. This may induce a fall in energy prices in the long run and the TE price will be on a downward trend as well. On this long-term trend, there should be periods of high fluctuations associated with elevated market volatility. When the actual price is far below the predicted price, one may consider a profitable (in the short run) share purchase. When the actual price is far above the predicted price, it is best to sell. Currently, the predicted and observed prices are almost equal. No action needed.
Figure 1. The evolution of defining CPIs.
Figure 2. Observed and predicted TE share prices.
Figure 3. The model standard error is $0.85.
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.