4 Of The Best Stock Valuation Methods
Stock valuation is a skill every successful investor must master. It involves calculating a stock’s intrinsic value, which is believed to be different from the current market price. The value you get lets you determine whether a stock is undervalued or overvalued at its present market price.
Valuing your stocks correctly enables you to identify the risk that comes with investing in a stock. Accurate stock valuation provides the information needed to make informed investing decisions. Outlined below are the top four stock valuation methods.
1. Discounted cash flow valuation
Discounted cash flow (DCF) is a valuation model that allows you to determine the value of an investment based on future cash flows. This method is ideal for companies with irregular dividends or those that don’t pay dividends. DCF evaluation takes into account the time value of money while offering a comprehensive view of an organization’s financial health, including:
- Growth rates
- Expenses
- Revenue
- Cost of capital
The discounted cash flow method of valuing stocks is highly comprehensive and utilizes specific numbers that involve crucial assumptions regarding a business, like growth rate and cash flow projections. Considering this valuation method’s complexity, a DCF calculator can help simplify the process. With this tool, you can evaluate an investment’s earnings over its whole economic life and automatically estimate a stock’s intrinsic value.
2. Dividend discount model
The dividend discount model (DDM) estimates a stock’s intrinsic value using a stock’s approximated dividend growth, present-day dividend rate, and a company’s capital cost. Its purpose is to calculate a stock’s fair value despite the present market conditions. If the value obtained from the DDM valuation method is higher than the stock’s current price, it means it’s undervalued, which makes it perfect for investing or buying.
The DDM method comes in handy when determining dividend-paying stocks’ value and is primarily beneficial if dividends are the main reason you wish to invest in stocks. With standardized DDM, you can systematically screen for appealingly priced dividend payers.
3. Dividend growth model
The dividend growth valuation method, also called the Gordon growth model, is a mathematical approach in which investors calculate a stock’s reasonable fair value based on future dividends that rise steadily. This valuation method assumes that an organization’s dividends grow at a stable rate forever, providing investors with the company’s current value depending on the future dividend payment series.
Since this valuation model assumes a steady growth rate, it’s often used for companies with stable dividend-per-share growth rates. If the value you get from this model exceeds the shares’ current trading price, the stock is seen as undervalued, qualifying it for purchase.
4. Comparable company analysis
Unlike other stock valuation methods that calculate a stock’s intrinsic value, comparable company analysis, also known as comps, compares the price multiples of a stock to a standard to find out if the stock is overvalued or undervalued. The comparable company analysis method can be used in nearly all conditions because of the large of multiples you can use, including:
- Price-to-book (P/B)
- Price-to-earnings (P/E)
- Price-to-cash-flow (P/CF)
- Price-to-sales (P/S) and more
P/E is the most commonly used ratio because it concentrates on company earnings, which is the main driving force of investment value.
Endnote
Learning how to value stocks enables you to make informed investment decisions. Discounted cash flow valuation, dividend discount model, dividend growth model, and comparable company analysis are the top stock valuation methods you should know.
This post originally appeared at MoneyMiniBlog.
Category: Stocks
