What is stock valuation?
Stock valuation is the method of calculating the theoretical values of stocks. It is the determinant to which investors depend which stocks can be potentially bought (undervalued) or sold (overvalued).
There are several stock valuation methods that you can use to determine the true value of stocks, but we are not going to elaborate on each of them. Instead, we are going to talk about the 4 factors that are commonly useful in determining stock valuation.
4 Factors that determine stock valuation:
Price-to-Book Ratio (P/B) – The price-to-book or P/B ratio represents the value of the company if you ever sell it today. The book value usually consist of all the assets that you can sell along with the whole company which includes the equipment, building, land, bonds, stock holdings, etc.
Price-to-Earnings Ratio (P/E) – The price-to-earnings or P/E ratio is probably the most important determinant of all the ratios. If a stock price suddenly goes up even without a significant change in the company’s earnings, the P/E ratio would decide if it would stay up or not. Therefore, there should always be earnings to back up the stock price in order for it to stay on its current value.
PEG Ratio – Looking at the P/E ratio on its own is not enough to determine the fair value of a stock. It is also important to use the price-to-earnings growth ratio or PEG. The PEG ratio shows the historical growth rate of the company’s earnings. The P/E ratio may indicate where the company is currently at. On the other hand, the PEG ratio will show where the company has been. It also plays a big role in finding the direction to which the company would head next.
Dividend Yield – Most investors go into stocks because of the promises of capital growth, while others prefer making fixed income from dividend stocks. Dividend-paying stocks are sought after because they provide a steady cash flow regardless of the stock’s price. The dividend yield shows how much payout you get relative to the stock you own. You can compute this by dividing the annual dividend by the stock’s price. The dividend yield is usually expressed as a percentage or a ratio. This indicates the interest you get on the money you invest, with more potential growth through the appreciation of the stock’s value.
A company giving out dividends doesn’t automatically mean a healthy company. Looking at the dividend history of a company should show whether it has great potential or not. A company that pays inconsistent dividends through the past years means you cannot count on its dividend yield.
Read more about getting to know fixed income investing.
These 4 factors are very important in stock valuation. It is not enough that you focus on just one because that would focus on very narrow choices. Combining the 4 factors may result to a better view of the stock’s worth.
Also, keep in mind that even with thorough analysis; you won’t be able to get the exact value of a stock. What you would get is a range in which lies the possible fair value of the stock.
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