Stock Valuation – A Primer.

What is stock valuation?
Stock valuation is the process of determining the fair value of a stock. Stocks analysts value a corporation’s stock based on its fundamental data and deduce a fair value for its stock price.

What is the purpose of stock valuation?
Stock valuation tells an analyst whether a stock is under-valued or over-valued and this information can is used in the trading of the particular stock.

What are some common stock valuation methods?
The following are some of the commonly used valuation methods.

i) P/E Ratio: The P/E ratio is calculated using the following formula: [share price/earnings per share]. This ratio is often used to compare a corporation with its peers within the same industry to determine whether its stock price is under-priced or over-priced.

ii) Discounted Cash Flow: Discounted cash flow or DCF is a popular valuation method used by analysts. In this method, a growth rate of a corporation is first calculated. This growth rate and the corporation’s current cash flows are used to make future cash flow projections.

The net present value or NPV of the corporation is then deduced using the future cash flowing and discounting it back to the present using a discount rate.

iii) Multiples: In this method a corporation’s value is measured as a multiple of earnings or cash flows or revenues. In some case multiples of comparable companies’ values can be used. The actual value of the multiple is dependent on the industry.

For eg. a corporation’s value can be three times its annual revenue. Here three is the multiple used to calculate the value.