{"id":478678,"date":"2023-02-16T13:42:35","date_gmt":"2023-02-16T13:42:35","guid":{"rendered":"https:\/\/www.finder.com\/uk\/?p=478678"},"modified":"2024-10-11T18:22:20","modified_gmt":"2024-10-11T17:22:20","slug":"analysis","status":"publish","type":"page","link":"https:\/\/www.finder.com\/uk\/share-trading\/share-trading-guides\/analysis","title":{"rendered":"How to value stocks"},"content":{"rendered":"

If you want to start investing directly in stocks and shares, prepare to put some effort into researching the companies you\u2019re interested in. As well as looking into the qualitative aspects of a company \u2013 such as how it\u2019s managed and whether it has any compelling USPs \u2013 a bit of qualitative number crunching will enable you to put a value on the stock and check whether it fits with your investment strategy. Here\u2019s how to get started.<\/p>

What is stock valuation?<\/h3>

Stock valuation is the process of using analytical methods to calculate the intrinsic value of a stock. It\u2019s a process that investors use to help them decide whether to buy a stock, depending on their investment goals.<\/p>

There are several ways to value stocks, and the most appropriate method depends on the nature of the company you\u2019re considering investing in. For example, more established companies with a proven track record of steady profits may require a different valuation method than new startups that haven\u2019t yet made any profits.<\/p>

Is a stock\u2019s value the same as its market price?<\/h3>

It depends on your perspective. Strictly passive investors might argue that market price and stock value are almost always the same because all relevant information is priced into a stock. Therefore, they would typically be happy to mainly invest in index (or tracker) funds, which look to match rather than beat the performance of a stock market index, such as the FTSE 100<\/a>.<\/p>

However, others would argue that a stock\u2019s intrinsic value may differ from its market price. This would particularly apply to active investors looking to choose investments that beat the performance of indices. They calculate a stock\u2019s value using a set of metrics and may then compare this value to its market price (and potentially the value of other similar stocks) before deciding whether to buy (or sell).<\/p>

What are the types of stock valuation?<\/h3>

There are 2 broad categories of stock valuation: absolute and relative.<\/p>

What is absolute stock valuation?<\/h4>

This involves analysing the fundamental performance of a business on its own merits without comparing it with any other companies. Absolute valuation calculations focus on things such as dividends, cash flow and growth rate. Methods include the dividend discount model and discounted cash flow model.<\/p>

What is relative stock valuation?<\/h4>

Relative stock valuation takes into account the performance of other companies. You carry out the same calculations for both the company you\u2019re interested in and peer firms and use this comparison to assess whether the stocks you\u2019re considering are worth it. There are relative stock valuation methods, including price-to-earnings, price-to-sale and price-to-book ratios.<\/p>

What is the most common way to value a stock?<\/h3>

One of the most common ways to value a stock is through a company\u2019s price-to-earnings (P\/E) ratio. This is a variant of a relative valuation method. This is calculated by taking a firm\u2019s stock price (total value of all a company\u2019s outstanding shares) and dividing it by its most recently reported earnings per share (EPS). A company\u2019s basic EPS should be reported in its financial reports. Alternatively, you can calculate it by working out a company\u2019s net profit (net income with any dividend payments substracted) and dividing the figure by the number of outstanding shares.<\/p>

The price-to-earnings ratio is commonly used to calculate stock value because it focuses on earnings, which is one of the key drivers of an investment\u2019s value. However, it isn\u2019t appropriate in all circumstances, not least because some newer companies won\u2019t yet have earned anything.<\/p>

What is a good price-to-earnings ratio for a stock?<\/h3>

That depends on your priorities and the investment strategy<\/a> you\u2019re following. A good price-to-earnings ratio (P\/E ratio) for one investor may not hit the mark for another. For example, a growth investor might seek out stocks with a high P\/E ratio on the basis that this indicates a high growth rate. Meanwhile, a value investor might prefer stocks with a low P\/E ratio. This would typically imply that the market price is below the stock\u2019s actual value and that the stock is, therefore, a bit of a bargain.<\/p>

What other ways are there to value a stock?<\/h3>

Our summary below outlines some of the methods used to value stock. It\u2019s not a comprehensive list of all possible methods, but it should give you a flavour of the key options available to you as a prospective investor.<\/p>

Absolute valuation methods<\/h4>