Basics of Stock Market - Beginner

Stock Valuation – Meaning, Methods and Formulas

Stock picking is a key part of investing. Stock picking is an art and one should not rush. It is important to do your research thoroughly and be patient before you invest. Before you choose a stock, there are certain parameters that must be carefully analyzed. First, let's understand what stock valuation means. This is how you determine the stock's value using certain formulas. Let's learn about the different methods used for stock valuation. There are two stock valuation methods: absolute and relative.

Absolute Value:

This method focuses primarily on determining the intrinsic value of a stock. The intrinsic value of a stock refers to the stock's true value. This can be determined using two methods: the dividend discount model or the discounted cash flow model.

Dividend Discount model:

This model is based upon a theory that says a stock is worth all future dividends.

Model of Discounted Cash Flow:

This model allows us to calculate the company's current value based on future cash flows.

Relative Value:

This model allows you to compare your stock's parameters with similar assets, which will help you determine the price. This includes techniques such as Price Earnings, Price/Earnings, Price/Earnings Growth, Price/Book Valu, Price/Sales Valu and Price/Cash flow. These techniques are explained in detail.

  • a. Price Earnings (P/E).

    This ratio can be used to determine how much an investor will pay for every rupee of earnings from a company. Investors have higher expectations of the company's earnings if a stock has a higher P/E. However, a stock with a high P/E ratio is overvalued. A stock with a low ratio of P/E is considered undervalued. Comparing similar stocks can help you determine if a stock is undervalued, or overvalued.

  • b. PEG Ratio:

    PEG=P/E --------------
    Rate of growth in earnings

    A PEG ratio of one indicates a perfect correlation between the company’s current market value, and its projected earnings growth. This ratio is higher than 1 and lower than 1. The stock is overvalued.

  • c. Price/Sales Value:

    P/S = Price per Share divided by Sales Per Share Stocks with a lower P/S are considered cheaper than stocks with a higher one.

  • d. Book Value/Price:

    P/BV= Price per share/Book value per share

The net worth is represented by the book value. A lower P/BV ratio means that investors believe the company's assets have been overvalued. A high P/BV ratio indicates that investors think that the assets are undervalued.

It is important to understand how stock markets value stock for trade. This will allow investors to make informed decisions about investing.

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