Stock valuation methods represent the process an investor will use to determine the worth of an individual stock. These methods provide technical insight on whether or not the investor can confirm his assumption of a stock providing an acceptable future return. Stock valuation methods typically focus on earnings, revenue, equity, or growth rates. Each method focuses on a specific area so the investor can test different aspects of each stock. Some methods also provide an analysis on the company behind the stock, which is often more important than just looking at numbers.
Earnings-based valuation focuses on the net income and earnings per share of a company. Each quarter, a company will report the earnings per share for the previous three months. The simple way to calculate this figure — although it is readily available on many investment websites — is to divide net income for the period by total diluted shares outstanding. Investors often forecast future earnings per share using this method to determine the amount of possible growth for the earnings per share of the stock.
Revenue-based stock valuation methods focus on a metric known as the price-to-sales ratio. The ratio divides the company's current market valuation by its revenue for the trailing 12 months. Market capitalization represents the outstanding diluted shares multiplied by the stock's current price plus current long-term debt obligations. Dividing this figure by the revenue produces a figure around 1.0; figures less than 1.0 are typically seen as hidden gems that stock markets may undervalue. This provides a good opportunity for making money on stock growth.
Stock valuation based on equity information is another common process used by investors. This method often focuses on the book value of a stock; book value is typically the total assets reported by a company less any intangible asset values listed n the company's balance sheet. Dividing this figure by the total diluted shares outstanding will provide investors with a figure known as book value per share. Current share prices that are below book value indicate a stock is actually selling at less than its actual worth. Therefore, the stock price should at least increase to the book value per share, in theory.
Growth stock valuation methods use the historical rates provided by a company for evaluation purposes. Some companies are seen as stable when they provide 1 to 2 percent growth every year. Returns are lower, but they are safe plays during tough economic periods. High growth stocks with 10 to 15 percent annual growth can be rewarding, but often have more risk associated with them. Once the company reaches a plateau in the market, growth tends to level off and become more stable, possibly negative as more companies enter the market.
