Best Stock Valuation Methods to Help You Earn More
There's something about identifying great stocks that requires a lot of careful time and consideration to get right. If you don't understand the best stock valuation methods to help with this investment process, there's a good chance that your strategy and art simply won't come together how you hoped.
Best Stock Valuation Methods
Thankfully, we are here to help! We researched a few of the most popular valuation methods used by brokers and other investors. These unique methods all help to improve your art by providing you with a focus that minimizes mistakes. Just as importantly, these processes all help to break apart the unique value of each of your stocks and give you a better understanding of their upsides and downsides.
The Two Basic Stock Valuation Methods
When breaking down these stock valuation concepts, it is vital to understand the two underlying concepts that unite them. All valuation methods break down into either absolute or relative valuation. These ideas provide a comprehensive understanding of stock but vary in how they are executed and what they measure. Let's break these down now to learn more about these unique concepts and how they drive all valuation methods discussed below in this article.
Absolute Valuation – Finds the “True” Value of an Investment
Most stock professionals prefer absolute valuation over relative for a number of reasons.
First, absolute measurements gauge the true value of a stock by examining its many fundamentals. These include things like the stock's cash flow, dividends, growth rate, and more. Many of the methods outlined below fall within this category and will provide you with a unique insight into your stocks and their overall value.
That said, there are some limitations to absolute valuation. First, it doesn't give you an idea of how well a stock compares to others. This information may be critical when deciding between various potential investments. Most valuation experts like to rely on absolute processes to get an understanding of a stock's general value and then move on to relative methods to learn more about its market potential.
That said, absolute valuations still provide you with an in-depth look at the value of a stock, one that minimizes your risk of making mistakes.
In addition, it can serve as an excellent background for your investment and help you better understand its past, future, and present.
Just as importantly, these steps help to fuel your relative valuation and give these processes a better grounding in market strength and its worth to you as an investor.
Relative Valuation – Measures Your Stock Against Others
Relative valuation models require you to compare your stock to other companies to get an idea of how they compete against them. It is often a profoundly complex method that requires looking at things like price-to-earnings (P/E) ratios, various other valuing multiples, and much more. Nevertheless, using this method helps to give you an idea of the relative strengths and weaknesses of a stock compared to many others.
While this method does require estimating a large number of values, it is also easier to execute because the available algorithms are more streamlined and easier to achieve. As a result, it is often a good idea to do a relative valuation first to get an idea of a stock's potential absolute value. Then, you can utilize the more in-depth and rewarding absolute valuation methods to learn more.
The downside of relative valuation is that it relies so heavily on absolute valuation to get an idea of the true value of a stock. While it is true that investors may start here to get a feel for a stock's value against others, it requires a deeper dive with absolute valuation to understand your best options here.
We strongly suggest a blend of absolute and relative methods to get the best results here.
How to Pick Different Methods
When picking between the varying absolute and relative valuation methods examined in the following sections, it is important to weigh a variety of different values. These factors will all dictate which of these options work the best for your needs and which are not suited to you. Just a few of the most important of these many elements include:
Stock Type
Your best valuation method will vary depending on what kind of stock you buy. When examining the different valuation options below, we'll touch on the best kinds of investments for each prospect, when applicable. These factors all help to dictate which method you should utilize.
Value and Pricing
Are you trying to create a balanced portfolio that doesn't put you in over your head? First, you need the best valuation methods suited for the specific stock types you're considering. Then, by understanding these elements, you can improve your overall investment strategy.
History With Investing
Do you have any experience with investing, or are you just getting started? Depending on your knowledge base, some valuation methods may work better than others. Stick within your wheelhouse but expand when possible to get a better overall understanding.
Quality of the Market
Where does your stock sit within the market? Is that particular field strong or struggling? Are there any unique valuation methods available to suit that specific need? Keep these factors in mind when choosing a method and research which makes the most sense for you.
When weighing these factors, it is a good idea to talk to various financial professionals to learn more. They can help to gauge your current economic health, give you a better understanding of what stocks may work the best for you. By taking this simple step, you minimize the risk of choosing investments that just aren't right for you. Now that we've got that out of the way let's look at some valuation methods.
An In-Depth Look at Various Stock Valuation Methods
In each of the sections below, we'll examine the various valuation methods available and how they work. We'll discuss whether they are absolute or relative and what benefits they provide. We'll also touch on the potential downsides of each option for investors like you.
By weighing these different pros and cons, you can get a better understanding of what they have to offer. This information should give you a good start and improve your investing success by allowing you to pinpoint the exact value of a stock and what kind of benefits or downsides it may possess.
Dividend Discount Model
Useful For: A Basic Understanding Of a Stock
As one of the simplest absolute valuation methods, it gives you a good and quick idea of the value of a stock. It starts by checking the dividends that a company pays the stockholder. Then, it begins by gauging whether or not a company pays dividends and whether they are stable and predictable.
For example, if a company pays a $1.00 dividend per share one month and a $0.50 dividend per share the next month, the stock's value is quite variable.
Typically, this model looks to see if the earnings per share (EPS) grows at a consistent rate or if it is stagnant or even decreasing.
This method works well with a very quick and basic understanding of a stock's value. However, it doesn't give you an in-depth look at why these dividends change so dramatically.
Discounted Cash Flow Model
Useful For: Companies With Irregular Dividends
Not every company pays regular dividend patterns. In this situation, it can be hard to gauge the absolute value of a stock using DDM. Instead, you may need to work with a Discounted Cash Flow Model or DCF. This method uses a slightly different model to figure out the stock value.
The most significant difference here is that it examines the firm's discounted future cash flows rather than the regular dividends. This method typically uses a two-stage process that forecasts the free cash flow of a stock for 5-10 years. But, first, it examines positive and predictable cash flow to gauge a stock's potential future.
In this way, it's even quicker than DDM and may be helpful in some situations. However, it is also less accurate and relies on a future that may never come.
The Comparables Model
Useful For: Comprehensive Stock Evaluations
This option is a good choice if the two options above aren't available for some reason and you need an in-depth analysis of a stock. Instead of looking at intrinsic or true values for your stocks, it uses price multiples and compares them to a specific benchmark.
This model follows the Law of One Price, an idea that claims that two similar assets or stocks should have a comparable price. This simple and intuitive idea sets a benchmark price and compares your stock to that price. It can use many different values to gauge this value and give you a comprehensive understanding.
For example, you can use the P/E ratio, the price-to-book analysis (P/B), the price-to-sales (P/S) value, and more. As a result, it is reasonably simple to use and shouldn't be hard to understand.
Asset Reproduction Value
Useful For: Situations With Many Competitors
Are you looking to invest in a stock with competitors that are likely to copy the business' approach? Then, you may need to consider this unique evaluation method to get the best results. It takes a look at your company's overall assets and examines their replacement value in depth.
This replacement cost helps to give you an understanding of the kinds of extra expenses that may impact a stock and what kind of payments they may need to make to stay solvent. It also gives you a more in-depth examination of their assets and how much they are worth before you invest.
Methods utilized here include square-foot measurements, units that they have installed, quantity survey methods, and index measurements.
Benjamin Graham Valuation Formula
Useful For: Big Companies With a Stable Business Model
Some stocks are simply more stable than others, with many companies possessing a very strong and capable understanding of the market. If you're interested in one of these firms, this model is probably your best choice. It utilizes a very simple formula that helps to ensure a reasonable valuation.
The biggest fault with this method is that it is too simple. While it is nice to have a quick and easy way to value so many companies, it doesn't give you the most in-depth information available. Nevertheless, this option is helpful as an essential guide and as a way of gauging undervalued stock options.
Earnings Power Value
Useful For: Gauging Firms With Volatile Cash Flow
Are you looking at a company with a cash flow that seems to vary wildly? This type of firm may seem like a hard sell at first. However, it can be an excellent option for the right investor. As a result, this particular method may be the best option for those interested in this type of stock choice.
This option is a good choice if you don't want to do estimates for future growth or if this option is not helpful for a company. In essence, it gauges a company with zero growth but creates sustainable profits, such as various service industries and firms within that field.
The EPV formula of adjusted earnings/cost of capital is very simple and gives you a pretty solid understanding of a company. That said, it looks at a company's past and does not always project forward to the future. This limitation may be frustrating for those trying to make the most cash.
The flip side of this option is the PE Model. It is suitable for companies with stable profits because it looks at a company's stock price versus its earnings per share.
How We Can Help
At Goalry, we can help improve your financial situation and make it easier to find stocks that meet your needs. That said, we are not a lender or a stockbroker. Instead, we provide an easy-to-understand system that you can utilize to research and identify the best financial help for your needs. Our app is streamlined, easy to use, and designed for both expert lenders and everyday people. In this way, you can get the most out of your financial experience and avoid choosing a solution that doesn't work for your needs.
Start by downloading our app and setting up your profile. Once your profile is done, you can seek out different financial institutions that may help you. These include various lenders, multiple stock valuation companies, stockbroker companies, and much more. Then, create personalized search variables, sort through your options, and set up alerts that warn you when a new financial source is available.
Utilizing our application gives you the chance to enhance your financial portfolio, invest in stocks that make sense for you, and learn more about your economic future. It is essential to utilize every resource you can find when investing in or valuing stocks. With our help, you should find it easier than ever to identify the kinds of financial sources you need to stay ahead of the game.
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Find Stocks That Meet Your Needs
If you work with our app and consider these stock valuation options, there's a good chance that you can improve your financial future. But, of course, predicting the stock market is notoriously difficult and requires a lot of patience and understanding. So you need to make sure that you take the time to assess these different factors and avoid complex, long-term issues that could impact your future.
That's why we strongly suggest patience and persistence when valuing potential stocks. You don't need to rush into this situation to get great results. Instead, it would be best if you focused on research, carefully understanding your available options, and choosing only those stocks that make the most sense for you. Even the most prominent stockbrokers will tell you that patience (and a little luck) go far here.