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If you’re new to stock trading, it can be tricky to decide what to invest in and how to determine its value. If you decide to invest in a major supermarket brand, how do you choose between similar companies like Kroger and Publix? Comparing the share prices of similar companies isn’t the same as calculating a stock’s real value.
Many investors use ratios to decide if a stock offers a good relative value compared to its peers. Here are the four most basic ways to calculate a stock value.
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Let’s say company ABC has a current share price of $100 and an annual EPS of $10 as stated in its latest report. $100 divided by $10 is a P/E of 10. So, at the current price, you’re expecting to buy 10 years of earnings.
While there’s no definitive P/E that’s considered “good,” over the last century the S&P 500 has averaged a P/E of slightly more than 15, which is sometimes seen as a broad threshold for fair value.
Company ABC has an estimated EPS of $11 over the next year as stated in its report. This is an increase of 10% over its current EPS of $10. Using the PEG formula of the P/E (10) divided by growth in EPS (10%), we have a PEG of 1.
Consider company XYZ. Its market price is currently $2, with 50 million shares issued. Total assets are $80 million and total liabilities are $20 million (this equals a book value of $60 million). Therefore, the P/B ratio is: $2 divided by ($60 million / 50 million) = 1.7
Companies create value and make money in different ways, so valuation ratios often depend on the company and industry. For example, a bank is valued by how many assets it has and how well it grows those assets, so the price-to-book ratio is a good measure of value. Retailers, on the other hand, aren’t looking to accumulate assets — they’re trying to sell products and make a profit. So price-to-sales or price-to-earnings ratios would be better measures of value.
In addition to the ratios above, which give you an idea of a stock’s relative value in line with similar companies, there are a couple more tips to help you figure out if a stock is priced fairly.
While relying on these analyst reports to determine intrinsic value or investment opportunities could be unwise, these reports may offer a more broad picture of a stock’s fundamentals.
No one wants to pay more than they need to. The basic goal of investing in stocks is to buy when the price is low and sell when it’s high to make a profit.
Valuing a company’s shares against similar companies in the market is one of the easiest ways to do this. It can help you figure out if you’re potentially paying too much for a stock, if you’ve found a bargain buy or if you’re holding onto a potentially overvalued stock.
Because technical analysis is primarily concerned with stock price movements as shown in charts, it’s largely used for determining and following the underlying trend or market sentiment rather than measuring the value of a stock. If people are buying a stock, a technical analyst can assume that the company is creating value. If people are selling a stock, the assumption is that it isn’t worth the current price.
Fundamental analysis, on the other hand, aims to determine the intrinsic, or true, value and the relative value of the stock so that an investor or trader can anticipate whether the stock price will rise or fall to realign with that value. Fundamental analysts attempt to discover this intrinsic value based on the company’s financial statements, including its earnings and debt. Relative value is determined by comparing businesses against their peers, like comparing the price of Dollar General stock with Dollar Tree stock or comparing Bank of America stock with Citibank stock.
You don’t have to pick one or the other, though. Investors and traders can use fundamental analysis to compile a list of stocks that are likely to be undervalued and then use technical analysis to buy or sell those stocks when the trend changes.
Now that you’re equipped with the knowledge you need to compare stocks, find an online trading platform that best suits your needs by comparing brokerage fees, available markets and more.
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While the value you think a company should have and the value the market is giving it can be quite different, fundamental analysis may provide early signs of opportunities or dangers that the market hasn’t yet priced in. Before investing, compare online trading platforms to find one with all the asset types and markets you want access to.
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