Stock valuation metrics are key financial tools that investors use to assess the relative value of a company’s stock. They help in determining whether a stock is overvalued, undervalued, or fairly valued compared to its financial performance, competitors, and the overall market. Here are some of the most widely used stock valuation metrics:
1. Price-to-Earnings Ratio (P/E Ratio)
- Formula: Market Price per Share / Earnings per Share (EPS)
- Purpose: Evaluates how much investors are willing to pay for each dollar of earnings. A high P/E ratio often signals growth expectations, while a low ratio may suggest undervaluation or lack of growth prospects.
2. Price-to-Book Ratio (P/B Ratio)
- Formula: Market Price per Share / Book Value per Share
- Purpose: Compares the market value to the book value (net asset value) of a company. A P/B ratio under 1 indicates that the stock is potentially undervalued relative to its assets.
3. Price-to-Sales Ratio (P/S Ratio)
- Formula: Market Capitalization / Total Revenue
- Purpose: Shows how much investors value each dollar of sales. This metric is useful for companies that don’t have positive earnings.
4. Price/Earnings-to-Growth Ratio (PEG Ratio)
- Formula: P/E Ratio / Annual EPS Growth Rate
- Purpose: Incorporates expected growth rates into valuation. A PEG ratio below 1 is generally seen as favorable, indicating the stock might be undervalued given its growth prospects.
5. Dividend Yield
- Formula: Annual Dividends per Share / Market Price per Share
- Purpose: Reflects the return an investor can expect in the form of dividends. It is crucial for income-focused investors who prioritize dividends over capital gains.
6. Dividend Payout Ratio
- Formula: Annual Dividends per Share / Earnings per Share (EPS)
- Purpose: Indicates what portion of earnings is paid out as dividends. A lower payout ratio can imply that a company retains more earnings for growth.
7. Enterprise Value-to-EBITDA (EV/EBITDA)
- Formula: Enterprise Value / Earnings Before Interest, Taxes, Depreciation, and Amortization
- Purpose: Offers insight into a company’s valuation considering both equity and debt financing. A low ratio might signify undervaluation.
8. Free Cash Flow Yield
- Formula: Free Cash Flow per Share / Market Price per Share
- Purpose: Measures a company’s ability to generate cash relative to its stock price. Higher yields generally suggest better value.
Conclusion
Stock valuation metrics serve different purposes, and using them in combination provides a comprehensive view of a company’s financial health and potential investment value. Investors should consider the company’s industry, growth prospects, and market conditions while analyzing these metrics to make more informed investment decisions.
Stock valuation calculator
To create a basic stock valuation calculator, it’s essential to have formulas that incorporate key financial metrics such as the price-to-earnings ratio, dividend yield, and others. Here’s a guide to calculating these metrics manually or through a spreadsheet.
Essential Stock Valuation Formulas:
- Price-to-Earnings Ratio (P/E) P/E Ratio=Market Price per ShareEarnings per Share (EPS)P/E Ratio=Earnings per Share (EPS)Market Price per Share
- Market Price per Share: The current trading price of a single share.
- EPS: Annual earnings per share.
- Price-to-Book Ratio (P/B) P/B Ratio=Market Price per ShareBook Value per ShareP/B Ratio=Book Value per ShareMarket Price per Share
- Book Value per Share: (Total Assets – Total Liabilities) / Number of Outstanding Shares.
- Dividend Yield Dividend Yield=Annual Dividends per ShareMarket Price per ShareDividend Yield=Market Price per ShareAnnual Dividends per Share
- Annual Dividends per Share: The total dividends paid out over a year.
- Price-to-Sales Ratio (P/S) P/S Ratio=Market CapitalizationTotal Annual RevenueP/S Ratio=Total Annual RevenueMarket Capitalization
- Market Capitalization: Market Price per Share * Number of Outstanding Shares.
- PEG Ratio (Price/Earnings to Growth) PEG Ratio=P/E RatioAnnual EPS Growth RatePEG Ratio=Annual EPS Growth RateP/E Ratio
- Annual EPS Growth Rate: Expected annual growth rate of EPS.
- EV/EBITDA Ratio EV/EBITDA Ratio=Enterprise ValueEarnings Before Interest, Taxes, Depreciation, and AmortizationEV/EBITDA Ratio=Earnings Before Interest, Taxes, Depreciation, and AmortizationEnterprise Value
- Enterprise Value (EV): Market Capitalization + Total Debt – Cash and Cash Equivalents.
Example Calculation
Assume a stock with the following details:
- Market price per share: $50
- EPS: $5
- Annual dividend per share: $2
- Book value per share: $25
- Market capitalization: $10 billion
- Annual revenue: $3 billion
- Annual EPS growth rate: 10%
- Total debt: $2 billion
- Cash: $1 billion
- EBITDA: $1.5 billion
Using the formulas:
- P/E Ratio 505=10550=10
- P/B Ratio 5025=22550=2
- Dividend Yield 250=0.04=4%502=0.04=4%
- P/S Ratio 10,000,000,0003,000,000,000=3.333,000,000,00010,000,000,000=3.33
- PEG Ratio 1010=11010=1
- EV/EBITDA Ratio 10,000,000,000 + 2,000,000,000 – 1,000,000,0001,500,000,000=11,000,000,0001,500,000,000≈7.331,500,000,00010,000,000,000 + 2,000,000,000 – 1,000,000,000=1,500,000,00011,000,000,000≈7.33
These calculations can be incorporated into a spreadsheet to automate the process. You can input the formulas into your preferred software (Excel, Google Sheets, etc.) and adjust as needed with different data points.
