How to decide the price of a stock

September 24, 2011

Knowing how to value a stock is extremely important before you take a buy call and invest your money.

Investing in equity markets needs knowledge of the concepts related to stock valuation. Whenever you consult an investment advisor on your investments, he will ask you to learn how to value a stock option yourself. Stock research is very important, and is the only way of looking for reasonably valued stocks in the stock market. Buying highly expansive stocks, as compared to their fundamentals and yearly profits, will never help you make money in the capital markets. This is because such over-priced stocks will come down eventually and can reduce your investment considerably. Finding cheap stocks is no child's play and requires knowledge of the methods of how to value a stock. In the next few paragraphs, let us acquaint ourselves with the methods of how to value a stock.
Methods of Deciding Stock Valuation
Analyze Financial Results :-
Analyzing financial results carefully, is one of the best methods to decide the right valuation for a stock. The company which posts healthy sales turnover and net profit can get a better valuation than its peers struggling to maintain their margins. This method of how to value a stock will give you profit at most times. Only in times of sudden stock market falls or heavy corrections can you go wrong with this method of stock valuation.

Look at the Earnings Per Share (EPS) :-
A method of how to value a stock is to look at the earnings per share ratio (EPS) of the stock. Companies which post high EPS are generally the market favorites, and will give decent return in the time to come. Low earnings per share can mean problems for the company on the execution front, because of which the net profits are under pressure. Reputed companies generally have good earnings per share ratio due to which such stocks are highly recommended.

Sales and Profit Growth :-
Another answer of how to value a stock is by observing the sales and profit growth of the company of the past few years. If you observe that the sales and profits are growing at a rapid pace, more than that of the entire industry, then you might consider taking some positions in the stock, even though the current earnings are not that well. It is important to consider the net profit, and not the gross profit, while you calculate the profitability of companies.

Watch for Debt Component :-
One thing you should always keep in mind is that investment should be done in debt free and high cash generating companies rather than those ridden in debt. The debt to equity ratio of a company should be comfortable, if you wish to buy stock of companies which have taken debt for fast expansion. What happens is that when the debt is too high, most of the income of the company is spent in repaying creditors, which leaves a very low net profit.

Market Capitalization :-
Another way to know how to value a stock is by observing its market capitalization growth. Stocks with high market capitalization should have equally strong earnings. In case the earnings are not at par with the current market capitalization enjoyed by the company, then the chances of the stock price falling down are more. Many experts suggest buying into mid cap and small cap stocks which are low priced and have a good growth potential.

By following these methods of how to value a stock, you will be able to buy stocks that are promising and thereby, earn cool returns through stock price appreciation, as well as dividends. So, think over it and act smartly. Good luck!

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