Stock valuation

Every investor who aspires to outperform the market must become an expert stock valuer. Stock valuation is essentially a technique for figuring out a stock’s intrinsic worth or theoretical value. The need of stock valuation arises from the fact that a stock’s intrinsic worth is independent of its market price. An investor may decide if a stock is overvalued or undervalued at its present market price by understanding the intrinsic value of the stock.

It is widely agreed upon that stock valuation is a very complex process that combines both art and science. The quantity of information that is theoretically accessible and that may be utilized to value companies (such as business financials, newspapers, economic data, stock reports, etc.) may be overwhelming to investors.

An investor must thus be able to separate the important information from the unimportant noise. An investor should also be familiar with popular stock valuation techniques and the situations in which they are used.

Stock Valuation Methods

The two primary categories of stock valuation techniques are absolute and relative.

• Absolute

The fundamental data about the firm is necessary for an absolute stock valuation. The process often entails the study of different financial data that may be found in or generated from the financial statements of a corporation. Numerous methods of absolute stock valuation focus largely on the cash flows, dividends, and growth rates of the firm. The dividend discount model (DDM) and the discounted cash flow model are notable absolute stock valuation approaches (DCF).

• Relative

Concerns about relative stock pricing arise from comparing the investment to those made in comparable businesses. The main financial ratios of comparable firms are calculated using the relative stock valuation approach, and the target company’s key financial ratio is then derived. The examination of similar firms provides the greatest illustration of relative stock value.

Common Stock Valuation Techniques

We will quickly go through the most common stock valuation techniques below.

Discount Model for Dividends (DDM)

One of the fundamental methods used in the valuation of absolute stocks is the dividend discount model. The DDM is predicated on the idea that a firm’s dividend payments reflect the cash flow of the company to its shareholders.

The concept essentially argues that the present value of the company’s future dividends equals the intrinsic value of the stock price. Keep in mind that the dividend discount model is only appropriate if a firm consistently provides dividends.

Model for Discounted Cash Flows (DCF)

Another well-liked technique for valuing absolute stocks is the discounted cash flow model. The intrinsic value of a stock is determined using the DCF technique by discounting the company’s free cash flows to its present value.

The key benefit of the DCF model is that it doesn’t call for any assumptions about dividend distribution. As a result, it is appropriate for businesses whose dividend distribution is uncertain or unexpected. However, from a technical standpoint, the DCF model is advanced.

Analysis of Comparable Companies

An example of relative stock valuation is a similar analysis. The comparable technique seeks to estimate a stock’s theoretical price using the price multiples of comparable firms rather than estimating a stock’s intrinsic value using the company’s fundamentals.

The price-to-earnings (P/E), price-to-book (P/B), and enterprise value-to-EBITDA (EV/EBITDA) multiples are the most often utilized multiples. From a technological standpoint, the similar business analysis approach is one of the easiest. Finding legitimately similar firms is the most difficult aspect, however.