# Top 7 Stock Valuation Methods To Find Winning Stocks

Table of Contents Heading

Numbers are usually reported as a GAAP EPS number and a Pro Forma EPS figure (income is adjusted to exclude any one time items as well as some non-cash items like amortization of goodwill or stock option expenses). The key is to take each approach into account while formulating an overall opinion of the stock. If the valuation of a company is lower or higher than other similar stocks, then the next step would be to determine the reasons for the discrepancy. The portion of the earnings not paid to investors is, ideally, left for investment in order to provide for future earnings growth.

- Thus, it is suitable for companies with unknown or unpredictable dividend distribution.
- A great company might not be a great investment if its stock is too expensive.
- A single share of a company represents a small ownership stake in the business.
- Owning stock in a company generally confers to the stock owner both corporate voting rights and income from any dividends paid.
- A stock’s intrinsic value, rooted in its business fundamentals, is not always the same as its current market price — although some believe otherwise.
- We analyze the company as though we would buy the whole thing and hold it indefinitely for all of its future free cash flows.
- And you calculate the fair price by summing up all future cash flows, and then discounting them based on your targeted rate of return.

The conjecture goes that as the percentage rises over 100% the stock becomes more and more overvalued, and as the PEG ratio falls below 100% the stock becomes more and more undervalued. The conjecture is based on a belief that P/E ratios should approximate the long-term growth rate of a company’s earnings. Whether or not this is true will never be proven and the conjecture is therefore just a rule of thumb to use in the overall valuation process. The discounted cash flow method involves discounting of the profits that the stock will bring to the stockholder in the foreseeable future, and a final value on disposal. The discounted rate normally includes a risk premium which is commonly based on the capital asset pricing model. For discussion of the mechanics, see Valuation using discounted cash flows.

## Two Categories Of Valuation Models

Owning stock in a company generally confers to the stock owner both corporate voting rights and income from any dividends paid. No single valuation model fits every situation, but by knowing the characteristics of the company, you can select a valuation model that best suits the situation. Often, investors will perform several valuations to create a range of possible values or average all of the valuations into one. With stock analysis, sometimes it’s not a question of the right tool for the job but rather how many tools you employ to obtain varying insights from the numbers. In this snapshot, the firm has produced an increasing positive operating cash flow, which is good.

The main use of stock valuation is to predict future market prices and profit from price changes. Another example would be for a company that has been going through restructuring. They may have been growing earnings at 10 – 15% over the past several quarters / years because of cost cutting, but their sales growth could be only 0 – 5%. This would signal that their earnings growth will probably slow when the cost cutting has fully taken effect.

## Stock Valuation

The other method, relative valuation model, compares one company to others in its peer-set. This one involves calculating multiples and ratios, such as the price-to-earnings multiple, and comparing them to the multiples of the companies in the same sector. Companies have an intrinsic value, and that intrinsic value is based on the amount of free cash flow they can provide during their effective lifetime. Money later is worth less than money now, however, so future free cash flows have to be discounted at an appropriate rate.

A company’s book value is equal to its assets minus its liabilities (asset and liability numbers are found on companies’ balance sheets). A company’s book value per share is simply equal to the company’s book value divided by the number of outstanding shares. The most common way to value a stock is to compute the company’s price-to-earnings (P/E) ratio. The P/E ratio equals the company’s stock price divided by its most recently reported earnings per share . A low P/E ratio implies that an investor buying the stock is receiving an attractive amount of value. A stock’s intrinsic value is based on projecting the company’s future cash flows along with other factors.

## Top 7 Stock Valuation Methods To Find Winning Stocks

EBITDA stands for earnings before interest, taxes, depreciation and amortization. It is one of the best measures of a company’s cash flow and is used for valuing both public and private companies. At the other end of the spectrum, investors of a “no growth,” or value stock will expect the firm to retain little cash for investment, and to distribute a comparatively greater proportion to investors as a dividend. Many valuation metrics are readily calculated, such as the price-to-earnings ratio, or price-to-sales, or price-to-book. But these are numbers that only hold value with respect to some other form of stock valuation. A DCF analysis is performed by building a financial model in Excel and requires an extensive amount of detail and analysis.

## The Dividend Decision

Unfortunately, the stock price you see in the newspaper or on your computer screen doesn’t say anything about how much a stock is really worth. A $100 stock is not necessarily more expensive than a $10 stock, and it may be in fact cheaper. The first step to figuring out whether a stock is cheap or expensive is measuring the market value of a company. Company ABC become one of the hottest stocks that year, rising 218% on top of a healthy 84% increase in 2016. However, by early 2019, the stock started to look overheated to Johnson. Your goal as an investor should be to find wonderful businesses and invest in them at reasonable prices.

## Price

Capital is distributed to investors via dividend payments and, indirectly, through capital gains. Investors hope that firms will use retained earnings to either maximize their current operations or invest in such as a way as to lead to higher profits. In other words, the portion of profits not paid out to investors via dividends is, ideally, left for investment in order to provide for future earnings growth. Value investing involves buying securities with shares that appear underpriced by some form of fundamental analysis. As examples, such securities may be stock in public companies that have high dividend yields, low price-to-earning multiples, or have low price-to-book ratios.

## Why Valuation Matters

The PEG ratio accounts for the rate at which a company’s earnings are growing. It is calculated by dividing the company’s P/E ratio by its expected rate of earnings growth. While most investors use a company’s projected rate of growth over the upcoming five years, you can use a projected growth rate for any duration of time. Using growth rate projections for shorter periods of time increases the reliability of the resulting PEG ratio. Solely using historical growth rates to predict the future is not an acceptable form of valuation. With millions of investors trying their luck, it is critical that the informed investor is putting in the time to study, evaluate and assess the fundamental factors affecting stock prices.

## An Example Of Stock Valuation

There are several methods for valuing a company or its stock, each with its own strengths and weaknesses. The comparable companies analysis method is one of the simplest from a technical perspective. However, the most challenging part is the determination of truly comparable companies. Below, we will briefly discuss the most popular methods of stock valuation.