It’s at the root of all stock market decisions, what exactly is that stock worth? Whether you are looking to buy or sell a stock you certainly want to know how much the stock’s true value is, and if it is currently undervalued or overvalued. If you don’t want to know the value of a stock’s worth, then you likely shouldn’t be investing in the stock market at all.
The truth of the matter is there are quite a few ways to try to determine how much a stock is worth, but only some of them are exceptionally important. Let’s take a look at five of the best ways to determine a stock’s value.
Five ways to value an individual stocks worth:
- Current financial position – You simply cannot value a stock without knowing what kind of financial position the company is in. Go through the balance sheet and income statement in particular to find out exactly how the company is using the money it is bringing in, and what the financial trends look like.
- Management/Profitability ratios – At the heart of the company that you are looking to invest money in is the management team. You’ll want to have supreme confidence that they know what they are doing and have a great plan. A terrific way to determine how the management is doing is looking through the profitability ratios. A stock’s worth can be much higher or much lower depending on how well the company does with its margins vs. those of their peers.
- Brand name/Economic Moat – Economic moat is a phrase coined by Warren Buffett that refers to a firm’s ability to consistently have a competitive advantage over its peers. This is a powerful thing that keeps other businesses from getting into the sector and makes the stock worth more in the long run. A strong brand name is one of the best examples of an economic moat. This one isn’t really one you can nail down a specific dollar figure to, but it can sway you in one direction or another as to the worthiness of an investment in the stock.
- Growth – Even if you are a value investor, the growth of the stock’s bottom line matters to you. If a company has no growth whatsoever you have to rely on pure valuation as your hope for capital appreciation, but if the stock has growth that must be factored into a price/earnings ratio.
- Future Earnings Power – Does the company have a nice pipeline of products coming out in the future? Is the company improving its return on assets or return on investment? What kind of cash flow does the company have? You’ll want to determine the level of future earnings power before putting a value on a stock.
Valuing the worth of a stock is basically equal to valuing the worth of the underlying company. After all, this isn’t just a stock or a piece of paper, but rather an investment in a business. As you are placing a value on an individual stock remember that what you are really doing is determining the worth of the sum of all parts of the company.
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Aaron K. Smith is a freelance writer with experience working in the mutual fund industry and writing about investing and the stock market. View all posts by Aaron.