Stock Valuation Method
New investors enter the stock market with great deal of enthusiasm but they soon realize that money making in stocks is not as rosy and easy. Majority of first time investors either quit investing in stocks or they realize that equity investing through mutual fund route is better. There are few minority investors who realize the golden rule of stock investing which is called ‘stock valuation’. An investor who has learnt the trade of valuing stocks are the winners of stock marke. There are numerous ways of stock valuation tips that investors will find online. But the overwhelming number of tips may confuse the investors. So in this article the team of getmoneyrich will propose some most effective methods of stock valuation.
The valuation of stocks can be done by using the method of finding worth of a company per share. This method is used by Warren Buffett and calls it intrinsic value of stocks. This is also called fundamental analysis of stocks which is calculated on basis of dividends distributed by the company, possibility of appreciation of value of market price of stocks, competitive advantage of company etc. In this form of worth analysis of a company the analyst do not care about comparison of the company in consideration with other competitors. If the worth of company per share calculated in this way comes out to be lower than the market price of share then it means the stock is overvalued. Intelligent investors will always avoid overvalues stocks.
The other form of stock valuation is slightly simple than intrinsic value calculation. Here the company in consideration is compared with its nearest competitors and evaluate that whether it is undervalued. The parameters on basis of which the companies are compared are P/E ratio, earning yield, return on capital etc.
Enough of the introduction, lets see some stock valuation tips:
Dividend Discounted Model
Dividend discounted model is one of the first step of calculating the intrinsic value of stocks. This is one of the great models of finding the ‘true’ value of the company. The true value of company can be estimated by knowing the dividends that a company can pays to its shareholders. Not all companies pays dividends but the companies that pays dividends are proportional to the net earnings earned by the company.
The dividend discounted model applies well for companies that pay steady dividends to its share holders. Generally companies which has large cap shares do afford to pay steady dividends to its shareholders. Hence we can say that dividend discounted model can be applied well to find valuation of shares of large cap companies.
Suppose a company A whose earning per share is increasing at a rate of 8% and whose dividend is also increasing at the same rate. It gives a hint that the company A is distributing a fixed portion of its net earning to its share holders. This way you can easily estimate that after five years (say) how much dividend may be paid by the company at a rate of 8% increase per year. Then you can use this dividend pay out to estimate the net earnings of the company (or better earning per share). If you know earning per share than you can easily find the correlation between market price of share and earning per share (P/E ratio).
Discounted Cash Flow Model (DCF)
Let the financial experts talk and speak whatever financial jargon’s they like but ultimately all stock market investment decisions bottoms down to the following two basic questions:
1) What is the value of business / company in consideration?
2) Is the right time to buy its stocks (whether current price is too high or OK for buying)?
Let me tell you, if an investor can answer the above two questions his majority job is done. After doing this analysis an investors will know which company is value for money and whether it is a right time to buy this stock.
Let’s see how this can be done by people like you and me who are not financial experts but like to invest in stocks like The Mr. Warren Buffett. Just keep in mind one small concept, in terms of stock purchase “Price is what one pays to buy a stock and value if what you get out of this stock in long term perspective”. Remember this analysis in not for stock traders who likes to buy stocks today and sell it tomorrow for petty profits. This content is addressed to everybody who is interested for long term investment and would like to benefit and grow with the company (the stocks that one owns).
Another important thing that I would like my readers to note that due to speculative nature of stock prices, the price of stocks keep on fluctuating above and below is actual value (worth). An investor must buy stocks when the price of stock goes below it value. Generally we buy stocks without knowing its value (worth). We compare the day to day prices of stocks and make decisions to buy or sell. This is ok if the prices falls by a huge margin (like during recent financial crisis), but how to take decisions when prices are falling only like 50-60 odd basis points? This is where the business value theory will come helpful for investors…read more
Let’s make it easy, ‘Compare and Evaluate Value’
This method is best for people who does not that much time and energy to calculate and evaluate value of share by doing intrinsic value calculations. So to make it simple for them, experts have devised a great way to compare apples to apples, it is called ‘ratios’.
The ratios like price earnign ratio (P/E), price to book value (P/B), price to sales ratio (P/S) and finally price to cash flow ratio (P/CF) are best options available with investors to compare between two companies of same sector. One can also used the dividend yield method to calculate whether the share is over valued or undervalued. If dividend yield is in fraction then it may suggest that the present market price of share is overvalued.
Conclusion
Stock market enthusiasts shall not that no one stock valuation is an ideal way of estimating value of stocks. But for sure intrinsic value method comes nearest to perfection. And this is the reason why the great investor Warren Buffett uses this method to evaluate the value of stocks.
The valuation of stocks can be done by using the method of finding worth of a company per share. This method is used by Warren Buffett and calls it intrinsic value of stocks. This is also called fundamental analysis of stocks which is calculated on basis of dividends distributed by the company, possibility of appreciation of value of market price of stocks, competitive advantage of company etc. In this form of worth analysis of a company the analyst do not care about comparison of the company in consideration with other competitors. If the worth of company per share calculated in this way comes out to be lower than the market price of share then it means the stock is overvalued. Intelligent investors will always avoid overvalues stocks.
The other form of stock valuation is slightly simple than intrinsic value calculation. Here the company in consideration is compared with its nearest competitors and evaluate that whether it is undervalued. The parameters on basis of which the companies are compared are P/E ratio, earning yield, return on capital etc.
Enough of the introduction, lets see some stock valuation tips:
Dividend Discounted Model
Dividend discounted model is one of the first step of calculating the intrinsic value of stocks. This is one of the great models of finding the ‘true’ value of the company. The true value of company can be estimated by knowing the dividends that a company can pays to its shareholders. Not all companies pays dividends but the companies that pays dividends are proportional to the net earnings earned by the company.
The dividend discounted model applies well for companies that pay steady dividends to its share holders. Generally companies which has large cap shares do afford to pay steady dividends to its shareholders. Hence we can say that dividend discounted model can be applied well to find valuation of shares of large cap companies.
Suppose a company A whose earning per share is increasing at a rate of 8% and whose dividend is also increasing at the same rate. It gives a hint that the company A is distributing a fixed portion of its net earning to its share holders. This way you can easily estimate that after five years (say) how much dividend may be paid by the company at a rate of 8% increase per year. Then you can use this dividend pay out to estimate the net earnings of the company (or better earning per share). If you know earning per share than you can easily find the correlation between market price of share and earning per share (P/E ratio).
Discounted Cash Flow Model (DCF)
Let the financial experts talk and speak whatever financial jargon’s they like but ultimately all stock market investment decisions bottoms down to the following two basic questions:
1) What is the value of business / company in consideration?
2) Is the right time to buy its stocks (whether current price is too high or OK for buying)?
Let me tell you, if an investor can answer the above two questions his majority job is done. After doing this analysis an investors will know which company is value for money and whether it is a right time to buy this stock.
Let’s see how this can be done by people like you and me who are not financial experts but like to invest in stocks like The Mr. Warren Buffett. Just keep in mind one small concept, in terms of stock purchase “Price is what one pays to buy a stock and value if what you get out of this stock in long term perspective”. Remember this analysis in not for stock traders who likes to buy stocks today and sell it tomorrow for petty profits. This content is addressed to everybody who is interested for long term investment and would like to benefit and grow with the company (the stocks that one owns).
Another important thing that I would like my readers to note that due to speculative nature of stock prices, the price of stocks keep on fluctuating above and below is actual value (worth). An investor must buy stocks when the price of stock goes below it value. Generally we buy stocks without knowing its value (worth). We compare the day to day prices of stocks and make decisions to buy or sell. This is ok if the prices falls by a huge margin (like during recent financial crisis), but how to take decisions when prices are falling only like 50-60 odd basis points? This is where the business value theory will come helpful for investors…read more
Let’s make it easy, ‘Compare and Evaluate Value’
This method is best for people who does not that much time and energy to calculate and evaluate value of share by doing intrinsic value calculations. So to make it simple for them, experts have devised a great way to compare apples to apples, it is called ‘ratios’.
The ratios like price earnign ratio (P/E), price to book value (P/B), price to sales ratio (P/S) and finally price to cash flow ratio (P/CF) are best options available with investors to compare between two companies of same sector. One can also used the dividend yield method to calculate whether the share is over valued or undervalued. If dividend yield is in fraction then it may suggest that the present market price of share is overvalued.
Conclusion
Stock market enthusiasts shall not that no one stock valuation is an ideal way of estimating value of stocks. But for sure intrinsic value method comes nearest to perfection. And this is the reason why the great investor Warren Buffett uses this method to evaluate the value of stocks.
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