Share Market

In the financial market ‘stock valuation’ is the method of calculating theoretical values of a company stocks. The main use of these methods is to predict future and potential market prices, and thus to profit from price movement. Stocks that are undervalued are brought with the expectation that their value will rise with time. While stocks that are overvalued are sold as their value will fall as a whole.

The most theoretical stock valuation method, called income valuation or discounted cash flow (DCF) method involves discounting the profits (dividend, earnings or cash flow) the stock will bring to the stock holders in future and a final value on disposal.

Stock valuation according to fundamentals analysis aims at giving an estimate of the intrinsic value of the stock, based on the prediction of the cash flow and profitability of the business. Fundamental analysis may be replaced by market criteria, which means what the market will pay for the stock without any necessary notion of the intrinsic value. These can be combined as “prediction of cash flow /profit”, together with “what the market pay for these profits?” These can be seen as ‘supply and demand’ – what underlies the supply of stock, and what drives the demand of stock?

Earnings per share (EPS) are the total net income of a company divided by the number of shares outstanding. The most important thing to look in the EPS is the overall quality of earnings. Considering the net income of the company and researching on fundamental investment, investors can arrive at their own EPS forecast, which can be applied to other valuation techniques.

The P/E (Price to earnings ratio) is perhaps the most commonly used valuation method in the stock brokerage industry. To compute this figure, take the stock price and divide it by the annual EPS figure. For example if the stock is trading at Rs10/share and the EPS is Rs0.50p, the P/E is 20 times. By using comparison firms, a target pricing/earnings ratio is taken for the company, and then the future earnings of the company is estimated. To get a good feeling of what P/E multiple a stock trades at, take a look at the historical and forward ratio.

Valuation depends on the growth rate of a company, price to annual sales of stocks (P/S ratio), market capitalization, and enterprise value.

Thus, market based valuation of a stock is very important.