Stock valuation

Stock valuation

There are several methods used to value companies and their stocks. They attempt to give an estimate of their fair value, by using fundamental economic criteria. This theoretical valuation has to be perfected with market criteria, as the final purpose is to determine potential market prices.

Fundamental criteria (fair value)

The most theoretically sound stock valuation method, called income valuation or the discounted cash flow (DCF) method, involves discounting of the profits (dividends, earnings, or cash flows) the stock will bring to the stockholder in the foreseeable future, and a final value on disposition.Fact|date=July 2008 The discounted rate normally includes a risk premium which is commonly based on the capital asset pricing model.

Approximate valuation approaches

Average growth approximation: Assuming that two stocks have the same earnings growth, the one with a lower P/E is a better value. The P/E method is perhaps the most commonly used valuation method in the stock brokerage industry.Fact|date=July 2008 By using comparison firms, a target price/earnings (or P/E) ratio is selected for the company, and then the future earnings of the company are estimated. The valuation's fair price is simply estimated earnings times target P/E. This model is essentially the same model as Gordon's model, if k-g is estimated as the dividend payout ratio (D/E) divided by the target P/E ratio.

Constant growth approximation: The Gordon model or "Gordon's growth model"Corporate Finance, Stephen Ross, Randolph Westerfield, and Jeffery Jaffe, Irwin, 1990, pp. 115-130.] is the best known of a class of discounted dividend models. It assumes that dividends will increase at a constant growth rate (less than the discount rate) forever. The valuation is given by the formula:

:P = Dcdotsum_{i=1}^{infty}left(frac{1+g}{1+k} ight)^{i} = Dcdotfrac{1+g}{k-g} .

and the following table defines each symbol:


Limited high-growth period approximation: When a stock has a significantly higher growth rate than its peers, it is sometimes assumed that the earnings growth rate will be sustained for a short time (say, 5 years), and then the growth rate will revert to the mean. This is probably the most rigorous approximation that is practical [ [ Discounted Cash Flow Calculator for Stock Valuation ] ] .

While these DCF models are commonly used, the uncertainty in these values is hardly ever discussed. Note that the models diverge for k=g and hence are extremely sensitive to the difference of dividend growth to discount factor. One might argue that an analyst can justify any value (and thatwould usually be one close to the current price supporting his call) by fine-tuning the growth/discount assumptions.

Market criteria (potential price)

Some feel that if the stock is listed in a well organized stock market, with a large volume of transactions, the listed price will be close to the estimated fair value.Fact|date=July 2008 This is called the efficient market hypothesis.

On the other hand, studies made in the field of behavioral finance tend to show that deviations from the fair price are rather common, and sometimes quite large.Fact|date=July 2008

Thus, in addition to fundamental economic criteria, market criteria also have to be taken into account market-based valuation. Valuing a stock is not only to estimate its fair value, but also to determine its potential price range, taking into account market behavior aspects. One of the behavioral valuation tools is the stock image, a coefficient that bridges the theoretical fair value and the market price.

On-line valuation calculators

* [] : Discounted Cash Flows Calculator that assumes that a higher growth can be sustained for a limited number of years.
* [] : A DCF spreadsheet that allows different growth rates to be specified for years 1, 2 to 4, 5 to 7 and 8 to 10.
* [ Baseline evaluation] : Automatically fetches baseline data for popular stocks. Allows valuation with different assumptions like variable excess return period.
* [ Public Company Valuations] : Free discounted cash flow (DCF) valuation tool for major listed companies.

See also

* Stock selection criteria
* Bond valuation
* Real estate valuation
* Active portfolio management
* List of valuation topics
* Capital asset pricing model
* Value at risk
* Mosaic theory
* Fundamental analysis
* Technical analysis
* Fed model Theory of Equity Valuation
* Undervalued stock


External links

* [ Development of the PE Valuation Method]
* [ MIT Open Course Ware]

Fundamental criteria (fair value) Citation for "Discounted Cash Flow Method" = [William F. Sharpe, "Investments", Prentice-Hall, 1978, pp. 300 et.seq.] () 13:07, 28 July 2008 (UTC)

Wikimedia Foundation. 2010.

Игры ⚽ Поможем написать курсовую

Look at other dictionaries:

  • stock valuation — ➔ valuation * * * stock valuation UK US noun [C or U] ► ACCOUNTING, COMMERCE, PRODUCTION the process of calculating the value of goods or materials owned by a company or available for sale in a store at a particular time, or the value that is… …   Financial and business terms

  • stock valuation — See: inventory valuation …   Accounting dictionary

  • stock valuation — See inventory valuation …   Big dictionary of business and management

  • stock valuation — /ˌstɒl vælju eɪʃ(ə)n/ noun an estimation of the value of stock at the end of an accounting period …   Marketing dictionary in english

  • stock valuation — /ˌstɒl vælju eɪʃ(ə)n/ noun an estimation of the value of stock at the end of an accounting period …   Dictionary of banking and finance

  • Stock selection criteria — is a strategy in which an analyst or investor uses a systematic form of analysis to determine if a particular stock constitutes a good investment which should be added to their portfolio. The objective of stock selection criteria is maximizing… …   Wikipedia

  • Valuation using multiples — is a method for determining the current value of a company by examining and comparing the financial ratios of relevant peer groups, also often described as comparable company analysis (or comps). The most widely used multiple is the price… …   Wikipedia

  • Stock image — can mean the following:* A stock image in publishing is an image that is commercially available (see stock photography). * A stock image in finance is a stock valuation coefficient based on the stock profile (growth, defensive, emerging, cyclical …   Wikipedia

  • Stock dilution — is a general term that results from the issue of additional common shares by a company. This increase in common shares of a stock can result from a secondary market offering, employees exercising stock options, or by conversion of convertible… …   Wikipedia

  • Valuation (finance) — Accountancy Key concepts Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow management · Chart of accounts  …   Wikipedia

Share the article and excerpts

Direct link
Do a right-click on the link above
and select “Copy Link”