Four common methods for valuing a stock
Fundamental investors generally base their investment decisions on the intrinsic value of a stock by considering the four methods for valuing a stock. “Intrinsic Value” refers to the actual worth of a stock based on an objective evaluation, as opposed to its current market price, which can be influenced by market sentiment and other external factors. This intrinsic value is determined by analyzing the company’s fundamentals, such as earnings, dividends, assets, and growth prospects. Fundamental investors aim to buy stocks when their market price is below their intrinsic value, anticipating that the market will eventually recognize the stock’s true worth, leading to price appreciation.
Formula
- PE Ratio = (Market Cap / Net Income) A useful valuation tool for comparison with steady earnings. The number of years it would take to recoup your investment given current earnings.
- PB Ratio = (Market Cap / Book Value) A valuation tool for analyzing cyclical stocks. The price investors are willing to pay unit of assets.
- PS Ratio = (Market Cap / Sales) A metric to evaluate stocks of non-profitable companies. The amount investors are willing to pay per dollar of sales.
- PEG Ratio = (PE Ratio / Expected Net Income Growth x 100) A common measure to asses high growth stock. Valuation in relation to earnings growth potential.