👍 What is stock valuation?
How much value does this stock I am buying/selling actually have against the stock price?
The valuation of stocks is ultimately a decision-making tool for buying or selling.
To succeed in investing in stocks, you must buy when the current stock price is undervalued (actual value) and sell when it is overvalued.
Then, you should be able to properly grasp the intrinsic value of the stock, right?
There are two models for that!
It is the dividend discount model and the relative value discount model.
For stocks with dividends, use the dividend discount model, and for stocks with no dividends, use the relative value discount model.
Stocks are not 100% sure because they are looking at "future" cash flows.
So, rather than sticking to one model, it's a good idea to go through the models below.
👍 Dividend discount model-Evaluate the stock bubble of a company with dividends
If you are a company that pays dividends, you can assess the value of securities through the dividend discount model because the dividend itself is the company's net income and future cash flows.
The dividend discount model is a method of dividing the expected [dividend + profit from trading] by the required rate of return and discounting it at the present value.
Demanded rate of return (k) = Nominal risk interest rate + (Beta coefficient X market risk premium)
👊 General model
Present value of stocks after n years = {Dividends after 1 year ÷ (1+k) + Dividends after 2 years ÷[(1+k)^2] + ... + Dividends after n years ÷[(1+k)^n]} + {n years later stock price ÷[(1+k)^n]}
Yes
The dividend was $500 last year and is expected to increase by 10% this year, and the stock price is expected to reach $15,000 early next year.
What is the present value of this stock with a risk-free rate of 5%, a market return of 10%, and a beta of 1.2?
Demanded return on stock = 5% + 1.2*(10%-5%) = 11%
Next year's expected dividend = 500*1.1 = 550
Present value of stock after one year = 15,550 ÷ 1.11 = 14,009
👊 Dividend discount model for fixed rate growth
If the company's growth rate is stable and the dividend growth rate (g) is constant, it is summarized by the sum of the infinite equality series as follows.
However, the required rate of return (k) must be greater than the dividend growth rate (g).
Present value of stock after n years = (Initial dividend x dividend growth rate) ÷ (requested rate of return-dividend growth rate)
Yes
A company's dividend last year was $1,000 per share, and dividend growth is expected by 7%.
What is the present value of this stock with a risk-free rate of 5%, a market return of 10%, and a beta of 1.2?
Dividend Growing = 1,000 * 1.07 = 1,070$
Required rate of return = 5% + 1.2*(10%-5%) = 11%
Present value of stock = 1,070 ÷ (11%-4%) = 26,750$
👍 Relative Valuation Model-Evaluate the stock bubble of a company with no dividends
For stocks where dividends cannot be used to determine cash flow because dividends are not paid, undervalued or high-valued items can be assessed using the relative valuation model.
Relative valuation models include PER, PBR, and PSR.
👊 PER(Price Earnings Ratio)
It is the current share price divided by the earnings per share (EPS), and it is an indicator of how many times investors are paying the price compared to the actual net income the company is making.
PER is the indicator most used by investors, and it is used when evaluating the stock price of a company that has no dividend but earns profit.
PER = Share price ÷ Earnings per share (EPS)
EPS (Earnings Per Share) = Net income ÷ Total number of shares issued
The PER of the company is based on the PER of the same industry/market average/past average as a benchmark (comparative basis).
If the PER value is higher than the standard, there is a lot of bubbles, and if the PER value is low, it is undervalued and it is a good place to buy.
Example
AE's earnings per share is $2,000 and is expected to grow by 10% every year.
The average PER of competitors in the same industry is 5x.
The market's overall PER is 6x, and AE's average PER for the past five years was 5.5.
How much can you estimate A-E's stock price one year later?
Earnings per share are calculated first after one year: 2,000 * 1.1 = 2,200$
Industry average: 2,200 * 5 = 11,000$
Market Average: 2,200 * 6 = 13,200$
Past average: 2,200 * 5.5 = 12,100$
In other words, the intrinsic value of the stock is $11,000, $13,200, and $12,100, respectively, when calculated with industry/market/past average PER.
👊 PBR(Price Book-value Ratio)
It is the ratio of the current stock price divided by the net assets per share (equity in the statement of financial position divided by the number of shares).
PBR = Share price ÷ Net book value per share (BPS)
BPS = Equity ÷ Number of shares
If the PER represents the relationship between the stock price and the revenue flow (flow rate), the range of fluctuations is large, while the PBR represents the stock (low volume) relationship between the stock price and net assets, and is characterized by being relatively stable.
In addition, as M&As are active in recent years, the importance of corporate asset values has emerged, and PBR is also widely used as an indicator of intrinsic valuation.
Usually, a PBR of less than 1.0 means that the stock price has fallen below the liquidation value and is said to be undervalued.
👊 PSR(Price to Sales Ratio)
It is used by companies that have no dividends and no profits to advertise as sales.
PSR = Share price ÷ Sales per share
Usually, a PSR of less than 1.0 is said to be undervalued, and a PSR of greater than 3.0 is said to be overvalued.