Every trader has wondered where share value comes from. Is it made up by corporate managers or somehow just a result of pure supply and demand factors? But an even more important question is how to arrive at a reasonably accurate estimate of what a given company’s stock is worth. The process is more than just a guessing game, even if no one can agree on a precise figure. Like figuring the fair price of land or used car, estimating corporate share value is half art and half science.
Luckily, there are several tried-and-true strategies for placing a relatively precise value on a listed stock. The first step for potential investors is to do plenty of research on the organization and the historical data related to valuation. It’s imperative to include at least two, but preferably more, parameters in your assessment. Consider measurements like price-earnings ratio, EPS data, and the dividend yield. Here’s how to get started.
Do the Preliminary Research
There’s no substitute for doing basic research on an organization you intend to include in an investment portfolio. Even if your conclusion is that the company is in trouble, there might be an opportunity to learn about short selling and play the market that way. However, it the shares appear to have potential for long-term growth, you’ll want to perform more detailed analysis in order to make accurate pricing estimates.
Check the EPS
The name of the measurement, earnings per share, is somewhat self-explanatory, but you still have to do the math. If ABC Corp. has annual earnings of £1 million and there are 4 million outstanding shares, the EPS is .25. In other words, the company’s income, spread among all the shares, is just one-fourth of a pound. EPS doesn’t show much all alone, but it’s a powerful indicator when comparing one organization’s financial strength to another. High EPS values tend to indicate that management is doing a good job of turning a profit for the benefit of shareholders.
Review P/E Ratio
To come up with a P/E ratio, you first need to calculate EPS as shown above. Then, the math is simple. Say a company’s EPS is .75 and its current share price is £5, then its P/E ratio is 5/.75, or 6.66. The ratio is not foolproof and there are several ways that it can give a false reading. But in many situations the P/E is a reliable indicator of whether a given share is over-priced. A ratio of 10 means investors are paying ten times as much as they should be for each share of the stock.
Don’t Ignore Dividend Yield
Dividend yield is one of the most significant measures of a company, based on how much actual cash it pays out to investors, compared to the buying price of the stock. The dividend yield of XYZ’s shares, which cost $200 and pay $2 per quarter in dividends, is four percent (8/200). You can compare the relative value of corporate stock based on this parameter. A higher dividend yield can mean a better bargain for the investor.