Setting Stock's Target Price

Step 1: Determine a target earnings per share for your stock.

a) First find the consensus estimate on Yahoo! Finance's individual stock quote pages, by clicking "Analyst Estimates." Or this can be achieved through reading one or more analysts' opinions
b) 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.

a) 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.
b) 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.
c) 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?
d) 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 - Cramer's Take - Stockpickr - Rating), 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.

Credit: http://www.thestreet.com/university/financeprofessor/10395936_1.html