• The Digital Accountant

How to Value Stocks and Shares

Being able to accurately value a share price will enable you to make more informed investment decisions. If you can identify a stock that is offered for a price lower than it's worth, you could make a significant profit from investing at the right time. Conversely, if you calculate a stock to be worth less than the offered price, you could avoid making a serious loss. These four elements of stock valuation will allow you to assess the true value of stocks and shares.

1. Price-to-earnings

The price-to-earnings ratio is an invaluable piece of information that any serious investor should ascertain before making any significant decisions. To calculate the ratio, simply divide the share price by the earnings per share. Low ratios represent a better opportunity as you will see a quicker return on your investment. Compare the ratio with other comparable shares to gauge its relative strength.

Like many stock valuations, P/E ratios are subject to change due to the calculation being based on predicted figures. Earnings-per-share can always fluctuate as the company evolves or develops, so it's important to not base any decision on a single calculation. Combine the findings of your P/E assessment with the results of further investigation to get a better overview of the true value of any stock.

2. Price-to-book

In order to avoid basing a valuation on earnings estimates, many investors put effort into establishing the price-to-book ratio of a stock. To get the P/B ratio, divide the share price by the company's current value. Being able to compare the share price offering with the company's worth can be extremely beneficial to an investor but it is notoriously hard to gain access to the information needed to make the calculations.

If you are able to ascertain a significant amount of data about the company offering the stock, you can make a fair assessment of their P/B ratio to help you in your judgment. Like with the price-to-earnings ratio, a lower number is better and represents a more reliable investment.

3. PEG

Investors looking to build upon their knowledge of a stock's P/E ratio will often attempt to calculate the price-to-earnings-growth ratio. Also known as the PEG ratio, the price to earnings growth focuses on a company's documented change in financial performance over a set period of time. By calculating the average change in earnings over a known period, an investor can predict how the business will perform in the near future.

As with the P/E method it's based on, the PEG ratio is limited in its reliability. Market forces can have sudden and unexpected effects on the performance of a company, so past performance can't be 100% relied on to predict future trends. However, the speculative nature of the PEG ratio means that a lot of money can be made, or lost, by investors willing to gamble on their estimations.

4. Dividends

Dividing the annual dividend by the price of a share will provide an investor with the dividend yield percentage. Unlike the previous calculations, a higher percentage figure is indicative of a more sound investment. If you're looking to make money from regular dividend payouts, it's essential to calculate the dividend yield before investing. A high yield percentage could indicate the stock is currently undervalued.

The amount received from dividend payments can vary, so it's helpful to calculate the average yield percentage for as wide a time period as possible. Fluctuations in yield percentage can temporarily portray a stock to be a more worthwhile investment that it may turn out to be over a longer time period.

By combining a number of different calculation techniques, a potential investor will gain a far greater understanding of stock value than could be achieved by relying on a singular method. Despite the inherent risk involved, investors are most successful when they fully research every opportunity. By putting in the time and effort to the gathering of information, you give yourself the best chance of making a significant amount of money in stocks and shares.

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