You may calculate the intrinsic value of a stock in a number of ways, but one of the most common and easiest methods of valuating stock is through its price-to-earnings ratio. The intrinsic value of any stock, however, does not necessarily mean that’s the price you’ll pay for it. Other factors that affect the price of a stock include human emotional responses and the overall market dynamics occurring at any given time.
1. Determine the stock's current trading price by reading the daily stock reports. Divide that number by the company's after-tax earnings over a 12-month period. This will give you the price-to-earnings ratio, or P/E, you’ll need for calculating the market value.
2. Find the company’s recent earnings statements in its quarterly reports or through the company website. The earnings per share, or EPS, is necessary to calculate the market value of the stock and determine whether it’s overpriced or undervalued before you invest.
3. Calculate the value of the stock by multiplying the P/E by earnings per share. "The higher the P/E," notes Barron's Dictionary of Finance and Investment Terms, "the more investors are paying, and therefore the more earnings growth they are expecting." You won’t find a P/E rate for companies that have negative earnings or are not profitable.
4. Use the intrinsic value as part of an overall estimate of future expectations for a particular stock purchase. As with all stock ratios and performance analyses, the market value is merely an estimate of how a stock will perform because it is predicated on expected future earnings, not facts that have already occurred.
- In addition to following a favorite stock tip website and the financial news reports, include in your research an institutional source that doesn’t rely on profits for its information. For example, the Center for Research in Security Prices, located at the University of Chicago, gives you historical financial data dating as far back as 1925. Historical data includes stock prices, market indexes and dividends and other distribution made by particular companies.
- Calculating market value is only one aspect of a sound investment strategy. Look at all the variables that make up a company and its viability. According to Trade4Rich, successful investors look at a company’s potential to make money for them. In addition to market values, factors that contribute to a complete picture of the company's health and potential include how much debt the company carries and what kinds of profit margins it is posting. The length of time that it has been trading on the public markets also gives you a clue to its performance. Finally, you should use common sense when evaluating stocks and consider the company’s growth history as well as how it stands out from its competitors.
Items you will need
- Current trading price
- Price-to-earnings ratio
- Earnings per share
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