The reason why investors must initiate for stock valuation is to predict the future price or potential market prices for the investors to purchase the best profitable stocks. The stock valuation fundamentals aim to value the intrinsic value of the stock that shows the profitability of the business and its future market value.
Stock performance is the measurement of a stock’s ability to increase or decrease the wealth of its shareholders. Stock performance is typically measured by its fluctuation in price. When the stock price increases, the stock shows good performance. Conversely, a decrease in price is a poor performance.
One common valuation metric is the P/E ratio, which involves taking the stock price divided by annual earnings per share. Companies with high growth rates typically sell for higher valuation multiples.
Also, the investor need to consider fundamental analysis, which helps in evaluating a stocks intrinsic value in order to find out its long-term investing opportunities. This analysis should also consider the overall condition of the economy and elements, such as production interest rates, employment, earnings, housing, Growth Domestic Product GDP, management, and manufacturing.
These elements are important as changes in interest rates can be more important than earnings. Because, when interest rates go up and all other things being equal, investors tend to withdraw money out of stocks and invest it into bonds and other fixed-income investments. They do so because the returns in bond investments are so attractive during high rates. Therefore, they tend to bring stock prices down and send bond prices higher. On the other hand, when interest rates come down again, then investors tend to shift money into stocks, reversing the previous trend.
Following are important indicators used to assess stocks
- Earnings Per Share (EPS)
- Price to Earnings (P/E) ratio
- Price to Book Value ratio (P/B)
- Dividend Payout ratio (DPR)
- Dividend Yield.
- Price/Earnings-to-Growth (PEG Ratio)
Price/Earnings (P/E) ratio
The most popular ratio for evaluating stock performance is the Price/Earnings P/E ratio, which compares Earnings Per Share to the share price. Price/Earnings P/E ratio is calculated by dividing stock share price by the company’s Earnings Per Share. Earnings Per Share is one the most useful measure which the investors benefit from for measuring stocks. It shows the amount of money that the company is earning on every share. Investor should invest in a company that its Earnings Per Share EPS increases in a consistent manner and shows superior management performance.
The Price/Earning P/E ratio should be based on the past five quarters and it provides the most accurate reflection of the current valuation. However, investors should always look into the future Price/Earnings figures by paying attention to estimates, which are widely available at financial statement of the most company’s websites.
In the world of stocks, investors should check Price/Earning P/E index, a price earnings ratio based on average inflation-adjusted earnings of a company from the previous 10 years. The best company to invest in is the one that its Price/Earning P/E Ratio is below 16. Price/Earnings P/E of 16 is a good barometer of what value an investor should be targeting. A Price/Earning P/E of 16 means that it costs an investor about 16 USD for every one USD of earnings they receive by investing in that stock. The higher the P/E ratio, the more investors are paying for each dollar of earnings. For instance, an investor should consider to invest in a company that has a lower P/E or below 16, rather than a company with a higher P/E or above 20.
Looking back in time, we can see that there have been a few periods that the Price/Earning P/E ratio for the S&P 500 has been above this level. For instance, before the crash of 1929, prices almost doubled and investors were paying up to 30 USD for every dollar of earnings from the S&P 500. And during the dot-com boom, investors were paying even higher for companies that had zero earnings.
PEG ratio
Investor can quickly compare Price/Earning P/Es and growth rates using the PEG ratio. To calculate PEG value, investor need to take the Price/Earning P/E (based on estimates for the current year) and divide it by the long-term growth rate. For instance, a company with a P/E of 36 and a growth rate of 20 percent has a PEG of 1.8.
In general, investor should invest in a stock with a PEG that’s close to 1.0 or lower, which means it is trading in line with its growth rate. But for a quality company, you can invest in a company that has PEG more than one.
Price/Sales P/S ratio
Price/Sale P/S ratio gives investors information on how much they’re paying for earnings. The Price/Sale P/S ratio is also useful to know how much they’re paying for revenue.
To calculate the Price/Sales P/S ratio, investor should divide the stock price by the total sales per share for the past 12 months. You could also use revenue estimates for the next fiscal year, which are being published more frequently on financial websites, instead of sales per share.
Like Price/Earnings P/Es, the Price/Sales ratios with fast-growers tend to get the highest valuations.
A company that has Price-to-Sales (P/S) ratios between one and two are generally considered good for investor to invest, while a Price-to-Sales P/S ratio of less than one is considered excellent. As with all equity valuation metrics, Price-to-Sales P/S ratios can vary significantly between industries.
Price/Book Value ratio
Price/Book Value ratio is a company’s total assets minus its total liabilities and intangible assets. In other words, it is a value when a company has been liquidated, and what the leftover assets would be worth after a company pay off all the creditors.
To find the book value on the balance sheet, book value is represented as shareholders’ equity. Dividing this total aggregate by the number of shares outstanding will give you a per-share book value.
This is a more conservative measure, which embraces a bird-in-hand philosophy of valuation. Investors can use the price to book value to identify whether the company’s stock is overvalued or undervalued.
For decades, the Price-to-Book (P/B) ratio has been favoured by intelligent investors, and is widely used by market analysts. Traditionally, any value under 1 is considered a good Price-to-Book P/B value, indicating a potentially undervalued stock. However, some investors often consider stocks with a P/B value under 3.
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