How Do Investors Value a Stock? Learning how investors value a stock is an eye opening experience for beginner traders and investors. So if you’ve ever wondered how investors decide the value a stock is worth, this short blog is for you…
And while I’ve written before about what to look for in a value stock, in this post we’ll go beyond value investing and look at a couple other common ways that investors typically value a stock. This will give you a more comprehensive (but still introductory) view of the ways you can value a stock yourself. Does that sound okay?
Fundamental Analysis and How Value Investors Value a Stock:
By definition value investors are concerned with how to value a stock. So let’s start there. Remember, there are many metrics value investors look-to in-order to gauge the true intrinsic value of the business. Here are some of the most common ways value investors value a stock…
Cost of Assets: One easy way to get a baseline limit for what the stock is worth is to figure out what the tangible assets of the company are worth. If the company you’re analyzing is worth less than the real estate it sits on, your investment has a margin of safety. Conservative value investors often use price-to-book value as a rough proxy for this measure and like to see it trading below 1.5.
Cost of Earnings: When you invest in a stock you are usually paying a premium for the earnings of the company. This is especially true if earnings are expected to grow. In fact, high earnings expectations can be very costly. Use the P/E ratio to get a feel for if you are paying too much or too little for the earnings a company produces. If you’re interested in investing based on earnings I recommend you read Common Stocks and Uncommon Profits.
Red Flags? Investors should always be cautious when valuing a stock. Otherwise it is too easy to inflate your price targets with optimism. Good investors should be able to see around the next bend when they are valuing a stock. Keep your eyes peeled for debt, dilution risk or even a bad business model. And adjust your price models accordingly.
But let’s look at another popular way investors value a stock…
How Growth Investors Value a Stock:
Value investing is only one approach for how investors value stocks. And in a lot of cases, it actually doesn’t make sense to value a stock based on what it’s doing today. This is especially true in high-tech fields like social media and biotechnology. So how do growth investors value a stock that is growing?
Future Earnings Projections are the main factor growth investors use to value stocks. This kind of earnings projections can quickly produce fabulous price targets. But growth investors interested in accurate valuations must be disciplined about which assumptions they agree with. Extrapolated results often work out well when they’re conservative… But… if you’re shooting for the moon and you come up short you have a long way to crash, right?
Growth Story: Is the narrative management tells about their future plans for growth and earnings expansion. It correlates closely with earnings growth projections. Understanding how management sees the market opportunity, and how they will translate it to shareholder value go a long way in helping growth investors value the stock of a company. Make sense?
Relative Valuation: If you’re looking at stocks that are growing, one good way to value that stock is to understand what investors are paying for similar stocks. You can use intra-industry analysis to give insight into what the market is willing to pay for your growth story and earnings growth.
Red Flags: While growth investors are more liberal in looking over red flags, they still keep an eye out for potential danger. And when valuing a stock with growth investing the red flags can be harder to see but more treacherous when they happen. Being able to distinguish between revolutionary products and product launch flops are what make the best growth investors stand far and above the others. But this isn’t easy to learn.
So here’s one last thing to consider when valuing a stock as an investor…
Technical Analysis Can Help Investors Value a Stock:
While the discussion about how investors value a stock is primarily fundamental in nature, there is also a space for technical analysis. That’s because over the long term both technical and fundamental analysis tell the story of a stock’s value.
The reason is:
Long term technical support and resistance lines clearly and objectively show how investors have valued a stock on the open market. And this picture is being updated everyday with short term price action. That’s why I always make a little room for stock chart trading ideas in my analysis. I’m by no means an expert. But the basics are easy.
If you want to learn more about how to use technical analysis in valuing stock I suggest you check out the best technical analysis videos. These stock chart videos can really help you improve your returns with swing trading techniques even if you’re a longer-term investor. Pretty cool, right?
So now let me ask you, as an investor, how do you value your stock ideas?
And By The Way: If you are still curious to learn more about how investors value a stock, I encourage you to sign up using the form below. It’s free and you’ll immediately receive a copy of my mini-ebook on how I developed my winning trading strategy. Check it out…