4/19/2021 How to Calculate a Company's Stock Price

How to Calculate a Company's Stock

Price
Small Business | Money & Debt | Stocks
By Jim Woodruff Updated February 01, 2019

Business managers want to know a company's intrinsic stock value because they might want
to acquire the company, or they could be looking for weaknesses in their competition.
Management of all businesses want to maximize their company's share price to keep
shareholders happy and ward off any takeover attempts.

How to Calculate Stock Price: An Example

Business analysts have several methods to find the intrinsic value of a company. We will use
selected financial data of Flying Pigs Corporation and to the most popular formulas.

Relevant financial data of the Flying Pigs Corporation is below:

Current Stock Price: $67

Last 12-months earnings per share: $4.19
Annual Sales: $217,000,000
Annual Dividends per share: $2.68
Historical P/E ratio: 18
Book Value per Share $55.84

Finding Value With the P/E Ratio

The most popular method used to estimate the intrinsic value of a stock is the price to
earnings ratio. It's simple to use, and the data is readily available. The P/E ratio is calculated by
dividing the price of the stock by the total of its 12-months trailing earnings. Companies that
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are growing rapidly will have higher P/E ratios compared to mature businesses with slower
growth rates. Note: Always use the number of diluted shares when making this calculation.

To calculate the current intrinsic value of a stock, find the company's average historical P/E
ratio and multiply by the projected earnings per share.

Intrinsic Value = P/E Ratio X Earnings Per Share

P/E Ratio Worked Example

Let's say the historical P/E ratio for Flying Pigs Corporation has been 18. The current P/E ratio
is $67 divided by $4.19 equals 16 times. If it were trading at its historical P/E ratio of 18, the
current stock price should be 18 times $4.19 equals $75.42. On this basis, current stock price
of Flying Pigs is underpriced. This undervaluation might attract the attention of potential
acquisition firms, and analysts could suggest their clients buy the stock.

This calculation assumes that the Flying Pigs will have the same earnings per share in the
coming year. If earnings are expected to increase, then the projected share price would be
even higher.

A stock selling at a low P/E ratio does not necessarily mean that it is attractive just because
the price appears undervalued. There might be reasons for the lower price: demand for their
products is down, the company is losing customers, management makes mistakes or maybe
the business is in a long-term decline.

Calculating Value With the Benjamin Graham Formula

Benjamin Graham is a legendary investor who developed a model that calculated the intrinsic
value of a stock based on a set of fundamental principles. His formula uses earnings per
share, book value per share and assumes a re P/E ratio of 15. Graham believed that no
company should sell at more than 1.5 times it book value.

His formula is as follows:

Intrinsic Value = Square root of (15 X 1.5 (Earnings per share) X(Book Value per share))

Benjamin Graham Worked Example

Applying this formula to Flying Pigs, the Graham number is below:

Graham Number = square root of (15 X 1.5 $4.19 X $55.84) = $72.55 = Maximum intrinsic
value

On this basis, the current share of $67 for Flying Pigs is undervalued compared to its Graham
number of $72.55.

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Using the Dividend Discount Model to Find Value

The dividend discount model can be simplified to the Gordon growth model. This formula
utilizes a company's dividends per share, the shareholders' required rate of return and the
expected growth rate of dividends.

The Gordon growth formula takes a company's dividends per share and divides by the rate of
return minus the dividend growth rate to equal the intrinsic value.

Value of Stock = Dividends per share/(Stockholders rate of return - dividend growth rate)

Dividend Discount Worked Example

Applying this formula to Flying Pigs, the dividend growth rate is projected as 7 percent, and the
shareholders rate of return is 11 percent:

Value of Stock = $2.68/(0.11 - 0.07) = $67

On this basis, a share of Flying Pigs selling at $67 is equal to its intrinsic value as calculated
by a dividend discount formula.

Putting it all Together

When attempting to determine the intrinsic value of a stock, no one method should be used
exclusively. As you can see from these calculations for Flying Pigs, the intrinsic values are not
all the same. In addition, other factors such as strength of the competition, management
changes, economic conditions, advances in technology and changes in consumer preferences
must be considered. A value calculation cannot be based solely on numbers from financial
statements.

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REFERENCES RESOURCES TIPS WARNINGS WRITER BIO

R E L ATED ARTI C L E S

How to Value How to Equate How How to Common

Shares of a Stock Price to Dividends Calculate Stock
Company Business Become a Business Valuations
Value Liability of a Market Cap
Corporation

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Examples of Business Valuations

By Leslie McClintock

People buy and sell businesses -- or stocks in businesses -- for two reasons: an expectation of
future dividends or an anticipation that the stock will eventually appreciate in value, even if no
dividends are paid. While not every stock will be a good investment, any company can be a bad
choice if you pay too much to own it. Before you buy a company -- whether you buy it whole or
just a few shares' worth -- you should understand how businesses are valued to help ensure
you are making a solid investment.

Price-to-Earnings
Business is all about earnings. In the long run, if you don't have earnings, or at least a
reasonable path to profitability, there's not much point in maintaining the business. The price-
to-earnings ratio is a measure of the business's profitability relative to its cost. Simply divide
the share price by the earnings per share. This gives you an idea of what it costs you to "buy" a
dollar of current earnings per year. If a stock selling for $10 has earnings of $1 per share, the
price-to-earnings ratio, or P/E, is 10. It costs you $10 to buy $1 of earnings. Low P/Es are good
for investors, all else being equal.

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Book Value
The book value of a business is whatever would be left over if the owners decided to liquidate
the entire business immediately, ceasing operations and selling off the assets to the highest
bidder. The proceeds would be used to pay off all the business's creditors, including vendors,
employees and bondholders. If the number is positive, and there is cash left over at the end of
the process, a business has a positive net worth.

Price-to-Book Value
The price-to-book value ratio is what you would pay for the business to get the book value of
the business. The book value is sometimes a useful "floor" for the valuation of a business. If a
business has a share price that is less than it's book value per share, shareholders have a
"margin of safety," in that if the worst happened and the business had to shut down tomorrow,
they would still eventually be able to recoup their investment through the sale of assets.

Dividend Discount Model

The dividend discount model relies on an estimate of future cash flows from the company that
would be available to pay dividends to owners. The theory is that the value of a business is
equal to the expected future stream of dividends discounted back to the present time, at
prevailing rates of interest. A dividend being paid tomorrow would be counted as a greater
value than a dividend payable in a year. Similar calculations can be made with free cash flow, if
the company is not currently issuing dividends. This model disregards assets on hand, since
the book value of a company only becomes relevant in the event of a liquidation. Book value is
an indication of the liquidation value of a company, while the dividend discount model values
the company as a going concern.

REFERENCES RESOURCES WRITER BIO

R E L ATED ARTI C L E S

What Causes How to Sell What Are How to How

a Company's Your Business Retained Calculate Dividends
Intrinsic Value Valuation Earnings in Business Become a
to Be Different Models Accounting? Market Cap Liability of a
Than Its Corporation
Market Value?

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