Valuation of a stock is an important part of value investing to pick the right stock. If you find or research a stock that have fulfilled all the criteria of good investing points like fundamental ratios etc then will it right to invest on a stock just on the basis of fundamental ratios and management analysis? Of course NO. You have to check or calculate also the right value of this stock to add your portfolio. You think now “what is valuation ,valuation of a stock formula and how to calculate valuation of a stock to pick the right?”
What is valuation?
Valuation of a stock in trade is the present value or worth of the stock. Let’s understand with an example, you want to buy a shoe from market. So you go to the market and asks the shop owner the price of the shoes that you choose. If you get a quality shoe on low price then it is a great deal. On the other if you get it in high price then it is surely not a great deal.(here the price,low or high depends on the shoes quality,cloths,style etc.). Now this same formula is suitable for valuation of common stock.
Valuation of stock in trade:
Your aim before invest in a stock may be earn more or secure your future. So you have to pick the right value stock. You shall get a value (stock) for your price (invest). Are you confused between value and price? Ok i explain the difference between value and price.
Value is what you get (here it is bond,stocks etc.) and Price is what you pay (here it is money or bond etc.). If you find a value stock in low price then the stock is called undervalued. On the other hand, if you trade it on high price then it is called overvalued and it is not a great deal.
Valuation of common stocks:
For valuation of company or stock it is not mandatory to calculate or find the exact value of this stock(fair value) or company.. Just you have to calculate near fair value or an average value of this stock. Like you have to the man’s size(like is he tall or short) not his height how tall he is. If stocks are trade in high price (basis of fair value) then it is overvalued.
Types of valuation:
There are many way to calculate the right value of a stock. They are:
1) Net asset value method.
2) Sum of parts.
3) Discount cash flow method.
4) Precedent transaction analysis.
5) comparable company analysis etc.
Here i discuss sum of parts method. It is one of the easiest method of valuation.This type of valuation is eligible only for two types company.
First,the company that manages the business in different fields. Imagine company ‘S’ manages different business like textiles,water bottle,consultancy etc. In this case you have to find the value of every company that is under on it.
Second, the holding company or the company which invest their money in different companies. Like company ‘ X’ invest 30 percent of ‘ Y’ ,’ Z’. In this case you have to calculate the value of Y and Z company to get the real value of X company.
Valuation of stock formula or valuation calculator:
Calculation of intrinsic value:
Value of stock=((E*(8.5+2G)*44)/Y
Here,E= earning per share(EPS).
G= growth rate of future 3 or 5 years.
Y= average AAA corporate bond yield.(just search it google and yow will get the result”.
Let’s understand it with an example: imagine a stock of B company’s eps (earning per share) 20 and growth in next 5 years 10 percent(for this check last 5 years growth ) and Y is 7.2(just search on google about AAA corporate bond yield). Now E=20.G=10.Y=7.2. Putting this into the valuation of stock formula we get the value of this stock is 348.33.
| EPS | 20 |
| GROWTH(in future) | 10 |
| AAA corporate Bond | 7.2 |
| Avg value | 348.33 |
Value=((20*(8.5+2*10)*4.4)/7.2
=348.33(putting the valuation of stock formula)
Valuation’s problems and solutions or advantages and disadvantages:
Problems/disadvantages:
1)in the name valuation people see the competitor or same field stock’s price and compare it with the company. If the price is low than others then people think this undervalued. But in real it may not. So conscious about it.
2) You should not pick any stock only on the basis of valuation in stock market.
Solutions/advantages:
1) The good thing in stock market is the price of stocks are decided by people.When people become emotional like lockdown effect,economy depression etc or other reason the value of this stock are decrease or increase.it is right time to buy a stock if the value of a good stock is decreasing because the company will fight back and grow quickly.
Now you know what is valuation,valuation of stock formula,valuation of common stock etc. then investing is so easy but it is not so. You can not pick a good value stock on the basis of valuation.Then everyone would be a successful investor. You should check other ratios like pe ratio, pb ratio etc. and do fundamental analysis,understand company’s product quality or service etc. You should be careful on every bit which helps to analysis the stock and wait for the moment when the stock will be valued or undervalued.
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