A beginner’s guide to stock valuation

By Navarre Trousselot. Published at Aug 5, 2020, in Investor 101

How do you work out which stocks represent sensible long-term investments? Navexa's Navarre Trousselot dives into the world of valuing potential investments on the stock market.

With more than 2,200 listings on the ASX, how do you choose a single stock to invest in?

For many of us — especially those of us who hunt for value over the long term — the process begins with valuing a company whose shares trade on the stock market.

It won’t come as a surprise that there are many ways to go about valuing a company.

We all approach investing and building wealth in our own way.

Just as some investors look for high potential growth stocks that could explode hundreds of percent higher in a short time...

And others prefer to buy and hold large, relatively stable stocks for a long time...

There’s a variety of options available to you as you evaluate the value of a potential investment.

Here, we explain a few of the main ones.

First, though ...

What does it mean to value a stock — and why should you do it?

When you buy shares, you own a fraction of the company whose stock you acquire.

This means that before you buy shares in it, it makes sense that you understand the business you’re buying into.

This, in turn, means you need to delve into the business’s finances.

The phrase ‘due diligence’ refers to this process.

If you don’t know what you’re buying into, then you’re not investing.

You’re gambling.

Your due diligence — the necessary research, in other words — is what differentiates a bet from an investment (which is still a risk, of course, but a calculated one).

Determining a business’s financial health allows you to understand whether or not its share price accurately reflects the company’s value.

The stock market is seldom a perfect reflection of the value of the companies trading shares on it.

After all, everyone in the market is looking for opportunities to make money by speculating on the future.

This means that a company’s shares can easily trade below or above the ‘true’ value of the business they represent.

This is where valuing a stock gets interesting.

Popular ways of valuing a stock

The simplest measure investors use when trying to get a handle on a stock’s value is the price to earnings ratio, or P/E ratio.

The P/E ratio is the current share price divided by what the company earned for every share over the past year.

Generally speaking, the higher the P/E ratio, the more overvalued you might say a company’s shares are.

A lower P/E, on the other hand, might indicate the market undervalues the shares relative to the overall health of the business.

Other common ways to approach valuation include:

Cash flow: While a stock might not be getting much love from investors and trading cheap, you might fight when you dig into their financials that the business has a strong cash flow (that they make a good return on their spending, in other words). This could be an indicator that the share price will rise higher as the market notices the business making more money in the future.

Debt ratio: Work out how much money the businesses owes to others. Low debt, generally speaking, is a positive sign that a company is healthy and its stock price may rise in the future.

Assets/liabilities: Another helpful ratio to deploy in valuation research is assets/liabilities. This is exactly what is sounds like. Divide the value of the company’s assets by the value of its liabilities. The higher the ratio, the better.

Using Navexa’s Built-In Value Calculator

There are, as they say, many ways to skin a cat.

When it comes to valuing a stock, there’s a huge array of ratios, calculations and methods available to help you get an idea of where a company’s shares are trading relative to its ‘true’ value.

It’s up to you to find the method that best fits your investing style and wealth building goals.

But to make life a little easier for our users when they are trying to value a stock, we’ve built a simple value calculator into our portfolio tracker.

Our calculator uses the discounted cash flow method.

This method determines the value of an investment based on future cash flow.

It’s based partly on hard, current numbers, and partly on predicted or forecast future numbers.

This method is similar to what Warren Buffett uses to value a stock.

If the discounted cash flow works out to be higher than the current cost of the investment, this is an indication that the price could rise in the future.

It’s not guaranteed or 100% accurate. No method that estimates future events can be.

And it is just one of the ways to go about determining value when evaluating a stock.

We recommend you try different methods until you find one that suits you best.

Navarre is the Founder of Navexa — a portfolio analytics service made for Australian investors. Navarre left a lucrative corporate developer job to combine two of his passions; investing and entrepreneurship. He created Navexa because he couldn’t find a portfolio analytics service that met his own high standards. Now, he’s focused on helping as many Australians as possible get more from their portfolios through the smart and creative use of data. Follow Navarre on Twitter and connect with him on LinkedIn.

This article was originally published on https://www.navexa.com.au/blog/a-beginners-guide-to-stock-valuation


Where to invest $1,000 right now

When the experts at Next Investors have a stock pick, it may pay to listen.

The Next Investors have been investing in ASX small cap stocks for years, with their best small cap picks yielding returns of 1,200%, 1,120%, 900% and 678%.

They have just revealed their hand-picked, FY2021 stock portfolio of high conviction long-term investments.

Click the link below to see what they are currently investing in.


SEE THE PORTFOLIO

S3 Consortium Pty Ltd (CAR No.433913) is a corporate authorised representative of LeMessurier Securities Pty Ltd (AFSL No. 296877). The information contained in this article is general information only. Any advice is general advice only. Neither your personal objectives, financial situation nor needs have been taken into consideration. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs, before acting on the advice.

Conflict of Interest Notice

S3 Consortium Pty Ltd does and seeks to do business with companies featured in its articles. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this article. Investors should consider this article as only a single factor in making any investment decision. The publishers of this article also wish to disclose that they may hold this stock in their portfolios and that any decision to purchase this stock should be done so after the purchaser has made their own inquires as to the validity of any information in this article.

Publishers Notice

The information contained in this article is current at the finalised date. The information contained in this article is based on sources reasonably considered to be reliable by S3 Consortium Pty Ltd, and available in the public domain. No “insider information” is ever sourced, disclosed or used by S3 Consortium.

Australian ASX Small Cap stocks | Why Finfeed.com is Australia’s leading small cap publication

Founded seven years ago, Finfeed.com is Australia’s leading and longest standing website for investor and finance news, education and expert opinion.

Published by StocksDigital, Finfeed was created to report daily on the comings and goings of ASX listed stocks in the small cap market.

As the first digital publication dedicated specifically to this space, Finfeed soon became the most trusted publication in the market, quickly garnering over two million page views – a number that continues to rise.

Finfeed.com provides its readers with informative articles that tackle the latest in market moving #ASX small cap news, plus exclusive content you won’t find anywhere else. It is aimed at those with an interest in investing, market education, company performance, start-ups and much more.

Finfeed.com is the only media organisation operating under the strength of a Financial Services License and is backed by leading journalists and analysts all with brands of their own.

The website aims to inform, educate and entertain with content that drills down into the heart of financial matters.

Finfeed is a leading source of investor and market information, with everything investors need to know about how to invest written in a way that anyone can understand. 

Over the years, the website has expanded beyond exclusively reporting on small caps, to profile Australia’s leading ASX listed small, mid and large caps as well as some of the country’s most successful CEOs and business leaders to find out what makes them tick.

Every day you will find fresh content covering:

Fast Facts

Over 4,000 articles published

Over 2.3 Million Page Views and counting

Over 10,000 followers on social media

Subscriber list growing by 2% monthly

Thanks for subscribing!

X