STOCK AND STOCK VALUATION

Abstract
In today’s world, with the expansion of privatization and turning toward the purchase and
sale of shares, the need to extensive research is felt in the field of accounting and finance. One of
these important areas refers to the studies relevant to stocks valuation and specifying effective
variables in determining the price of shares. This study is done with the aim of testing different
valuation models of stocks based on basic variables in the economic environment to identify
basic variables as well as introducing a model for pricing stock through testing several stocks
valuation models which has the most important role in explaining the stock prices of companies.
The regression was used to test the stocks valuation models. The results obtained from this study
indicated that the model of price to book value ratio (P/B) has the highest adjusted coefficient of
determination and is determined as the best stocks’ valuation model among the models tested.

I. INTRODUCTION
Stock valuation is the process of determining the current (or projected) worth of a stock
at a given time period. Every investor who wants to beat the market must master the skill of
stock valuation. Essentially, stock valuation is a method of determining the intrinsic value (or
theoretical value) of a stock. The importance of valuing stocks evolves from the fact that the
intrinsic value of a stock is not attached to its current price. By knowing a stock’s intrinsic value,
an investor may determine whether the stock is over- or under-valued at its current market price.
Valuing stocks is an extremely complicated process that can be generally viewed as a
combination of both art and science. Investors may be overwhelmed by the amount of available
information that can be potentially used in valuing stocks (company’s financials, newspapers,
economic reports, stock reports, etc.). Therefore, an investor needs to be able to filter the relevant
information from the unnecessary noise. Additionally, an investor should know about major
stock valuation methods and the scenarios in which such methods are applicable.
II. UNDERSTANDING STOCK AND STOCK VALUATION
When deciding which valuation method to use to value a stock for the first time, it's easy
to become overwhelmed by the number of valuation techniques available to investors. There are
valuation methods that are straightforward, while others are more involved and complicated.
Unfortunately, there's no one method that's best suited for every situation. Each stock is different,
and each industry or sector has unique characteristics that may require multiple valuation
methods. In this article, we'll explore the most common valuation methods and when to use
them.
Stock valuation enables accurate control of stock, showing how much money has been
invested in items or materials and helping to prevent stock being lost or stolen.

This study source was downloaded by 100000877237621 from CourseHero.com on 03-19-2024 22:42:25 GMT -05:00

https://www.coursehero.com/file/90569147/Stock-and-Stock-Valuation-Garcia-Cheska-Kate-Hdocx/
 III. TYPES OF STOCKS VALUATION
Absolute stock valuation relies on the company’s fundamental information. The method
generally involves the analysis of various financial information that can be found in or derived
from a company’s financial statements. Many techniques of absolute stock valuation primarily
investigate the company’s cash flows, dividends, and growth rates. Notable absolute stock
valuation methods include the dividend discount model (DDM) and the discounted cash flow
model (DCF).
Relative stock valuation concerns the comparison of the investment with similar companies. The
relative stock valuation method deals with the calculation of the key financial ratios of similar
companies and derivation of the same ratio for the target company. The best example of relative
stock valuation is comparable companies’ analysis.
IV. STOCK VALUATION METHODS
There are many ways to value stocks. The key is to take each approach into account while
formulating an overall opinion of the stock. If the valuation of a company is lower or higher than
other similar stocks, then the next step would be to determine the reasons for the discrepancy.
1. Earnings Per Share (EPS)
EPS is the total net income of the company divided by the number of shares outstanding.
Numbers are usually reported as a GAAP EPS number (which means it is computed using
mutually agreed upon accounting rules) and a Pro Forma EPS figure (income is adjusted to
exclude any one time items as well as some non-cash items like amortization of goodwill or
stock option expenses).
2. Price to Earnings (P/E)
Once one has several EPS figures (historical and forecasts), the most common valuation
technique used by analysts is the price to earnings ratio, or P/E. To compute this figure, the stock
price is divided by the annual EPS figure.
3. Price Earnings to Growth (PEG) Ratio
This valuation technique has become more popular over the past decade or so. It is better than
just looking at a P/E because it takes three factors into account: the price, earnings, and earnings
growth rates. To compute the PEG ratio, divide the Forward P/E by the expected earnings growth
rate (historical P/E and historical growth rate are also used to see where the stock has traded in
the past).
4. Return on Invested Capital (ROIC)
This valuation technique measures how much money the company makes each year per dollar of
invested capital. Invested capital is the amount of money invested in the company by both
stockholders and debtors. The ratio is expressed as a percent and Return on Invested Capital ratio
should have a percent that approximates the expected level of growth. In its simplest definition,

This study source was downloaded by 100000877237621 from CourseHero.com on 03-19-2024 22:42:25 GMT -05:00

https://www.coursehero.com/file/90569147/Stock-and-Stock-Valuation-Garcia-Cheska-Kate-Hdocx/
 this ratio measures the investment return that management is able to get for its capital. The
higher the number, the better the return
5. Return on Assets (ROA)
Like ROIC, ROA, expressed as a percent, measures the company’s ability to make money from
its assets. To measure the ROA, take the pro forma net income divided by the total assets.
However, because of very common irregularities in balance sheets (due to things like goodwill,
write-offs, discontinuations, etc.) this ratio is not always a good indicator of the company’s
potential. If the ratio is higher or lower than expected, be sure to look closely at the assets to see
what could be overstating or understating the figure.
6. Price to Sales (P/S)
This figure is useful because it compares the current stock price to the annual sales. In other
words, it tells you how much the stock costs per dollar of sales earned.
7. Market Cap
Market Cap, which is short for Market Capitalization, is the value of all of the company’s stock.
To measure it, multiply the current stock price by the fully diluted shares outstanding
8. Enterprise Value (EV)
Enterprise Value is equal to the total value of the company, as trading on the stock market. To
compute it, add the Market Cap (see above) and the total net debt of the company.
9. EBITDA
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is one of the
best measures of a company’s cash flow and is used for valuing both public and private
companies
10. EV to EBITDA
This is perhaps one of the best measurements of whether a company should be valued as cheap
or expensive. To compute, divide the EV by EBITDA (see above for calculations). The higher
the number, the more expensive the company is.
V. VALUING NONCONSTANT GROWTH DIVIDENDS
Limited high-growth period approximation
When a stock has a significantly higher growth rate than its peers, it is sometimes assumed that
the earnings growth rate will be sustained for a short time (say, 5 years), and then the growth rate
will revert to the mean. This is probably the most rigorous approximation that is practical.
While these DCF models are commonly used, the uncertainty in these values is hardly ever
discussed. Note that the models diverge for and hence are extremely sensitive to the difference of
dividend growth to discount factor. One might argue that an analyst can justify any value (and

This study source was downloaded by 100000877237621 from CourseHero.com on 03-19-2024 22:42:25 GMT -05:00

https://www.coursehero.com/file/90569147/Stock-and-Stock-Valuation-Garcia-Cheska-Kate-Hdocx/
 that would usually be one close to the current price supporting his call) by fine-tuning the
growth/discount assumptions.

Implied Growth Models

One can use the Gordon model or the limited high-growth period approximation model to impute
an implied growth estimate. To do this, one takes the average P/E and average growth for a
comparison index, uses the current (or forward) P/E of the stock in question, and calculates what
growth rate would be needed for the two valuation equations to be equal. This gives you an
estimate of the “break-even” growth rate for the stock’s current P/E ratio. (Note: we are using
earnings not dividends here because dividend policies vary and may be influenced by many
factors including tax treatment).

Imputed growth acceleration ratio

Subsequently, one can divide this imputed growth estimate by recent historical growth rates. If
the resulting ratio is greater than one, it implies that the stock would need to experience
accelerated growth relative to its prior recent historical growth to justify its current P/E (higher
values suggest potential overvaluation). If the resulting ratio is less than one, it implies that either
the market expects growth to slow for this stock or that the stock could sustain its current P/E
with lower than historical growth (lower values suggest potential undervaluation). Comparison
of the IGAR across stocks in the same industry may give estimates of relative value. IGAR
averages across an industry may give estimates of relative expected changes in industry growth
(e.g. the market’s imputed expectation that an industry is about to “take-off” or stagnate).
Naturally, any differences in IGAR between stocks in the same industry may be due to
differences in fundamentals, and would require further specific analysis

VI. CONCLUSION
No single valuation model fits every situation, but by knowing the characteristics of the
company, you can select a valuation model that best suits the situation. Additionally, investors
are not limited to just using one model. Often, investors will perform several valuations to create
a range of possible values or average all the valuations into one. With stock analysis, sometimes
it's not a question of the right tool for the job but rather how many tools you employ to obtain
varying insights from the numbers.

This study source was downloaded by 100000877237621 from CourseHero.com on 03-19-2024 22:42:25 GMT -05:00

https://www.coursehero.com/file/90569147/Stock-and-Stock-Valuation-Garcia-Cheska-Kate-Hdocx/
Powered by TCPDF (www.tcpdf.org)