There are several ways to evaluate a stock's true value. While the share price is the first and most obvious indicator of a stock's value, there are other factors to consider. By looking deeper into a stock's fundamentals, you can determine a more accurate value than the value suggested by the share price alone. Always try to gather as much information as possible when calculating stock value and be cautious if you find a stock value that seems too good to be true.
Look up the stock price. You can look up stock prices through many different sources including financial websites and newspapers. The stock price is the benchmark you will use to determine the relative value of the stock. For the purposes of this article, assume that the stock in question is XYZ corporation and the current stock price is $15.
Calculate the P/E Ratio. The price to earnings or P/E ratio compares the share price to the earnings per share of XYZ. You can perform this calculation by yourself by dividing the share price by the earnings per share, although many financial websites save you the trouble of this calculation by simply giving the P/E ratio of stock.
Assume XYZ has earnings per share of $1. Therefore the P/E ratio for XYZ is $15/$1 or 15. This is a realistic example, although average P/E ratios may differ depending on the stock sector in question. If you find a stock with a relatively low P/E ratio, the stock may be a bargain.
Calculate the price to book value ratio. This is another simple fraction comparing the share price to the company’s book value. The book value is simply the value obtained from a company’s balance sheet when liabilities are subtracted from assets. A P/B ration of 3 or lower is a sign that a stock may be undervalued. Again, you will find book values on virtually all major financial websites.
Evaluate the stock’s value, keeping risks in mind. If you find a stock with relatively low P/E and P/B ratios, the stock may be undervalued and represent a good buy. If the ratios are high, that is a sign that the stock may be overvalued. Even if both ratios are low, that is not a guarantee that the stock is a good buy. If there is something fundamentally wrong with the company’s operations, this may be generating false undervalued signals because investors do not want to buy the company’s stock. Always get as much information as you can when determining a stock’s true value.
- The Motley Fool: How to Use the P/E
- Zacks: Education: Value Investing
- Yahoo Finance. "Berkshire Hathaway Inc. (BRK-A) Historical Prices." Accessed July 26, 2020.
- Yahoo Finance. "Berkshire Hathaway Inc. (BRK-A)." Accessed July 26, 2020.
- Microsoft Investor Relations. "Frequently Asked Questions." Accessed July 26, 2020.
- Yahoo Finance. "Microsoft Corporation (MSFT)." Accessed July 26, 2020.
Adam Parker is a writer from Virginia. He holds a Bachelor of Science from James Madison University. Parker has written articles for online sources including The Motley Fool, Gameworld Network and Glossy News.