Get Your Portfolio in Shape for 2008

Step 1: Determine a target earnings per share for your stock. This can be achieved through reading one or more analysts' opinions (see "Investment Research: Ignore the Ratings, Read the Reports"). You can also seek out the consensus estimate for a company's earnings . A consensus estimate is the average estimates for all analysts covering a particular stock. These estimates can be found on Yahoo! Finance's individual stock quote pages, by clicking "Analyst Estimates."

However, do not rely solely on those analysts' opinions (see "Ask TheStreet: Target Practice" and "Investment Research: Ignore the Ratings, Read the Reports"). Make any necessary adjustments to their estimates based on your own research or macro-level opinions. For example, if you are looking at a general merchandise retailer and the analysts whom you have read believe that the company will increase earnings by 10% in the next year, but you believe that overall consumer spending will slow down, then adjust the analysts' estimates accordingly.

Step 2: Determine a target price/earnings multiple for your stock. This is not a straightforward task and it will require some assumptions, but it's nevertheless possible and definitely important. So how does one determine a forward P/E for a stock? Here are a few techniques:

• Use the company's historical P/E ratios. While P/E ratios are not static, they do tend to move around a mean (average) value. This mean P/E should provide a good grounding for this analysis.

  You can use TheStreet.com Ratings to provide you with historical EPS and growth rates for individual stocks.

• Compare the company's P/E with that of its industry or closest competitors. There should not be a big discrepancy amongst competitors with an industry. However, the better companies will garner a premium multiple to that of their lesser competitors (see "Cramer's 'Mad Money' Recap: The Pizza Connection").
• Look at alternative investments. Consider the P/E for a risk-free investment. Let's say the five-year U.S. Treasury Note is yielding 5%. The P/E for this note will be the 20 (1 divided by .05). If you can earn a 20 P/E on a risk-free investment, then the P/E on a riskier investment needs to be considered in the context of its relative risk. In other words, why pay more for a riskier investment than a less risky one?
• Look at growth rates. This is what I refer to as the Cramer Rule. Jim Cramer states that you should never pay twice the growth rate for a stock. By that he means that the P/E should never be more than two times the expected growth in future earnings per share (see price/earnings-to-growth ratio ). You can use this benchmark as a rule of thumb. For example, if a company that you're invested in is expected to grow earnings at 15% next year, your forward P/E should not exceed 30 times earnings.

Step 3: Calculate an overall price target. Having your forward earnings estimate and P/E multiple, take the two numbers and multiply them to arrive at a price target for next year. For example, with Google (GOOG Quote - Cramer on GOOG - Stock Picks), I have estimated that the company will earn $21.25 EPS in 2008 and have applied a 40 target multiple (or P/E) on those earnings. This allows me to derive a price target of $850 ($21.25 multiplied by 40) per share .

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