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 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 to 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 2. Observed
and predicted PRU share prices.

Figure 3. The model
standard error is $6.01.

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