The process of calculating stock prices is commonly referred to as stock valuation. Stock valuation is most commonly used by asset managers, financial analysts, corporate managers, and other economists, although it can also be calculated by individual investors. Calculating stock prices is a complicated process, and there are a couple different ways to analyze costs.
Absolute vs. Relative Valuation
As noted by Investopedia, some stock valuation methods are simpler to use than others. For example, relative valuation models, which compare a given company's performance to other similar companies, are a bit simpler than absolute valuation models, which involve more calculations and require that you know all the company's fundamental data. Absolute valuation calculations use information about a company, such as cash flow, dividends and growth rate, in order to come to a conclusion about its true or intrinsic value.
Dividend Discount Model
The dividend discount model is one of the most common and simple ways to calculate a stock's price. The formula for this method is quite simple. You simply divide the stock's current dividends by its expected return minus the dividend growth rate. This method assumes that a given stock's value is determined by the amount of annual dividends, or the cash that is returned to the investor. Although it is one of the most common ways to calculate stock prices, the dividend discount model has a few weaknesses. It doesn't account for other similarly valued company performances and also leaves out several other important factors, like company growth. As noted by Investopedia, the dividend discount model is most accurate for mature companies that pay out sizable dividends to investors.
Price Per Share
You can also calculate a given stock's price if you know the earnings per share and the amount of outstanding shares. The formula is very simple. To calculate earnings per share, subtract the company's dividends paid on preferred stock from its net income. Then divide this figure by the number of outstanding shares. You can either use the number of outstanding shares for the current period or the average annual number of outstanding shares. As noted by Investopedia, keep in mind that earnings per share is not the only indicator of a stock's success. For this reason, it's best to know all the factors involved in calculating EPS before you make an investment.
The method you use to calculate stock prices depends primarily on your investment goals. Keep in mind that stock price calculations have one primary weakness: they can't account for future growth or decline. However, if you take the time to use several methods of stock analysis, your calculations will provide a general picture of your stock's success or failure. Remember that the size of the company also plays a significant role in calculating stock prices. As noted in "Stock Valuation: An Essential Guide," smaller businesses are more likely to be mispriced than large companies, since they have a smaller investment following.
- Investopedia: How to Choose the Best Stock Valuation Method
- Money-Zine: Calculating Stock Prices
- Stock Valuation: An Essential Guide; Scott Hoover
- Investopedia: Digging Into the Dividend Discount Model
- Investopedia: Earnings Per Share-EPS