Stock Valuation: Popular Methods to Value a Stock

Investors everywhere are looking for a way to gain an edge against the market that will result in profits. The best way to do that is to learn how to evaluate stocks. By understanding and using different stock valuation methods, investors can determine if a stock is undervalued or overvalued at its current market price, potentially leading to higher returns and alleviating the risks of missed opportunities and potential losses.

A wide variety of stock valuation methods are available for investors to use. Common techniques include price-to-earnings ratio (P/E), discounted cash flow (DCF) valuation, dividend discount model (DDM), price-to-earnings growth (PEG) ratio, price-to-book ratio (P/B) and price-to-sales ratio (P/S). By knowing how and when to use these methods, you can determine the intrinsic value of a stock and make smarter investment decisions.

What is stock valuation?

Stock valuation consists of several different processes to determine the intrinsic value of a company’s stock.⁽¹⁾ Intrinsic value of a stock, contrary to the stock’s fair value — an agreed-upon value — is a self-imposed educated guess on the stock’s real value based on fundamentals.⁽²⁾ By setting their starting point, savvy investors can determine if the price of a stock is overvalued, undervalued or fairly priced.

Let’s take Nvidia (NVDA) as an example. An investor might analyze and determine that Nvidia’s value is $140 while the current market price is $120.04, as of May 12, 2025. An investor might feel inclined to buy the stock as there is an indication that a market correction can lead to profits.

Key concepts for valuing a stock

• Earnings. The company’s net profits after all expenses, showing how much revenue is retained as profit.⁽³⁾
• Revenue. The total income a company brings in from sales before deducting expenses. Rising revenue often signals growing demand.⁽⁴⁾
• Cash flow. The actual cash a company produces or consumes.⁽⁵⁾ Positive, predictable cash flow underpins many valuation models.
• Market capitalization. The total market value of a company’s outstanding shares provides a quick sense of company size.⁽⁶⁾
• Risk. Riskier assets demand a higher expected return to compensate for increased risk.
• Dividends. A portion of a company’s profits that shareholders receive as regular payouts.⁽⁷⁾ Important for income-focused stock valuations like the DDM.
• Intrinsic value. The “true” worth estimated by an investor’s chosen model, independent of daily price swings.

Stock valuation methods: How to value a stock

Many stock valuation methods provide investors with valuable data, each tailored for specific cases and perspectives. Here are some of the most notable stock valuation methods:

1. Price-to-earnings ratio (P/E)

The most popular valuation method is the price-to-earnings ratio, commonly known as P/E, price multiple or earnings multiple. It’s a financial ratio that measures the current stock price relative to the company’s earnings per share.⁽⁸⁾

P/E ratio is the most popular valuation method because it provides investors with a quick and easy overview of the stock values within the same industry. However, P/E only works on stable, profitable companies. Investors should not use P/E for unprofitable or early-stage startups.

Dividing the current share price by the company’s earnings per share results in P/E. EPS is typically found on financial reports or stock websites.

The rule of thumb is that a P/E ratio of 10–20 is considered fair value. Beneath 10 is considered undervaluation, and above 20 is common for big stable companies or can indicate overvaluation.⁽⁹⁾ However, it is very dependent on the industry.

2. Discounted cash flow (DCF) valuation

Discounted cash flow (DCF) is a stock valuation method that estimates an investment’s value based on its expected future cash flows, using a discount rate to account for the time value of money (TVM).⁽¹⁰⁾ The time value of money is the idea that a dollar today is worth more than the same dollar in the future due to earning potential.⁽¹¹⁾ Investors use DCF to estimate the value of an investment using the expected future profits.

Since this valuation method is based on projections, it’s less suitable for valuing early-stage companies and startups with unpredictable cash flows. On the contrary, DCF may be applied to mature, stable companies with consistent earnings.

The best use of DCF for long-term investing is when reliable financial projections and data are available and when growth rates, cash flows and the appropriate discount rate can be reasonably estimated.

Where:

• Future Cash Flowₙ = expected cash flow in year n
• r = discount rate
• n = number of periods (typically in years)

Calculating DCF involves estimating future cash flows over several years, choosing a discount rate, discounting each cash flow to present value and summing the results.

For all savvy investors, here is a small cheatsheet:

• DCF > Market price = Indication that the stock may be undervalued.
• DCF < Market price = Indication that the stock may be overvalued.
• DCF ≈ Market price = Likely to be fair value.

3. Dividend discount model (DDM)

The dividend discount model is a valuation method that claims that a company’s stock price’s present value is the sum of all its future dividend payments when discounted back to their present value.⁽¹²⁾ An important factor for DDM is the TVM.

DDM takes the estimated value of all paid dividends in the future and calculates its net present value (NPV), which is based on the principle of the time value of money.

DDM is a valuation model that works best when applied to stable and mature companies that regularly pay dividends. A more accurate valuation can be made when the company has a strong track record of paying and increasing dividends.

To calculate DDM, use the expected annual dividend (Dividend₁), the discount rate (r) and the expected dividend growth rate (g). Divide the expected dividend by the difference between the discount rate and the dividend growth rate to estimate the stock’s intrinsic value.

Like DCF, DDM follows the same principles:

• DDM > market price = Potentially undervalued stock
• DDM < Market price = Potentially overvalued stock
• DDM ≈ Market price = Fairly valued

4. Price/earnings to growth (PEG) ratio

The price/earnings to growth ratio is the stock’s P/E divided by the growth rate of its earnings.⁽¹³⁾ PEG is a more encompassing ratio when compared to P/E, as another dimension has been added, which makes the projections more accurate but also more complex.

Investors should use the PEG ratio alongside the P/E ratio, especially when P/E may be misleading. PEG stock valuation is most useful for evaluating stable companies with consistent, high growth potential, especially in growth-oriented sectors like technology.

The PEG ratio compares a stock’s P/E ratio to its expected earnings growth rate, helping investors assess whether it’s fairly priced relative to its growth potential. A PEG below 1 suggests that the stock is undervalued relative to its expected growth, while a PEG above 1 may indicate the stock is overvalued relative to its growth outlook.⁽¹⁴⁾

5. Price-to-book ratio (P/B)

Price-to-book (P/B), also known as market-to-book, is a stock valuation method that compares a company’s market price per share to its book value per share.⁽¹⁵⁾ Market value per share is typically available on most stock trading platforms. Book value per share is calculated by subtracting total liabilities from total assets, then dividing by the number of outstanding shares.⁽¹⁶⁾ Investors can find both assets and liabilities on the company’s balance sheet.

Investors should use P/B primarily for asset-heavy companies, while refraining from applying the ratio for tech firms with a plethora of intangible assets, as the calculation may not accurately reflect the company’s true value.

A P/B less than 1 may indicate undervaluation, while a P/B above 1 could mean the stock is overvalued, often driven by growth potential or intangible assets.

6. Price-to-sales ratio (P/S)

The price-to-sales ratio (P/S) compares a company’s market capitalization to its revenue, helping investors assess how much they’re paying for each dollar of sales.⁽⁷⁾ Like with all stock valuation methods, P/S brings the most value when used for comparing companies within the same sector.

Investors use P/S for companies with negative, inconsistent or distorted earnings, but with strong and growing revenue. Companies like Spotify that heavily reinvest in growth, are reporting losses and show rapid revenue expansion, are great examples that analysts use for the P/S ratio.

A rule of thumb for reading P/S ratio:

• P/S < 1 = Potentially undervalued.
• P/S ≈ 1–2 = Fairly valued.
• P/S > 2 = Possibly overvalued (unless high growth).
• P/S > 10 = Very high valuation, typical for high-growth or early-stage companies.

How to value a stock

1. Select a stock and gather data. Collect financial statements, share price and analyst estimates.
2. Choose a stock valuation method. Pick the model that best fits the company’s profile and investor skill level.
3. Calculate the value. Plug the inputs into the chosen formula or model.
4. Compare it to the market price. Determine if the stock is overvalued or undervalued.
5. Cross-check with another method. The most important step is recognizing that no single stock valuation method is sufficient on its own.

Mistakes to avoid when learning how to value a stock

• Overusing one method. One method does not apply to all situations. For example, investors can’t effectively use PEG for stocks without a clear estimated growth.
• Using outdated data to calculate the fair value of a stock. Fair value estimates based on old financials or missing inputs can lead to misleading conclusions.
• Not combining stock valuation methods. Investors must bear in mind that the best stock valuation method is a combination of many.
• Not accounting the whole industry. Stocks shouldn’t be analyzed individually but in relation to other stocks and the rest of the industry.
• Neglecting market conditions. Many events can trigger changes to fair value, such as economic cycles, interest rates and sentiment.

Tips for how to value a stock

• Combine methods for accuracy. Blending ratios balance strengths and weaknesses. Relying on multiple approaches helps investors cross-verify results and reduce the risk of misleading signals.
• Adjust for economic trends. Factor in inflation, interest rates and macro risks in the discount rate. Ignoring the broader economic climate can make even solid valuations irrelevant.
• Focus on industry-specific factors. Tailor approach to sector norms (e.g., asset versus growth focus). For example, tech stocks may prioritize growth metrics, while banks are better valued using book value ratios.
• Use conservative assumptions. Build in a margin of safety to protect against forecast errors. It’s safer to undervalue than overvalue based on overly optimistic expectations.
• Revisit valuations regularly. Update inputs as new data and earnings reports arrive. Fundamentals change, and so should the investor’s valuation.

Bottom line

Stock valuation is a crucial component of a successful investment strategy. Without it, investors are prone to risks of losses and missed opportunities.

Before an investor starts buying stocks online, it is imperative to get acquainted with all valuation methods. Start from the easiest stock valuation methods, such as P/E and PEG, and then move on to more complex ones. Bear in mind that it is never enough to use just one stock valuation method.

Frequently asked questions

What’s the easiest way to calculate the fair value of a stock?

The easiest way to calculate the intrinsic value of a stock is the P/E ratio. The formula is the share price divided by earnings per share.

What is the PEG ratio, and when should I use it?

The PEG ratio is a stock valuation method that helps investors compare high‑growth firms with differing growth expectations by adjusting the P/E for expected earnings growth. Investors use PEG for companies with earnings growth.

Which stock valuation method is best for beginners?

The best stock valuation method for beginners is P/E. Investors can figure out the intrinsic value easily and promptly. P/E is also valuable for beginners because it provides insights into trends and the ability to compare stocks.

To make sure you get accurate and helpful information, this guide has been edited by Matt Miczulski as part of our fact-checking process.

Written by

Shane Neagle

Contributor

Shane's career started with the US Department of Defense where he performed research for 8 years. He then studied philosophy and became fascinated by the ways in which technology and finance can consolidate to impact the world's socio-economic order. To date, he has written hundreds of articles with various insights into digital assets, trading, investing, and the ways in which technology can be used to further optimize the stock trading and settlement processes. His work has been featured in Yahoo Finance, Nasdaq, Bitcoin Magazine, Investing.com, Tokenist, and others. See full bio