How to value shares
Don’t get confused, you must have come across various methods to value shares which might have left you all confusing. There are various methods by which you can value the shares and here we break it down to you in simple jargon-free language, how to value shares. The below-mentioned points will help you understand the valuation of shares in a better way:
Price to earnings ratio
The P/e ratio measures the relationship between a company’s stock price and its earning per shares of the stocks already issued. Now how it is calculated? Well, the formula is very easy, Price per share/Earning per share. What does it indicate? Simple, If the P/e ratio is high of a company then the investor and potential investor will have more confidence in the stock of the company and the demand of the company's stock will rise and will result in a higher valuation of the shares. P/e ratio helps a lot in the valuation of shares as it is directly related to the stock price. The P/e ratio can highly affect the value of the stock.
This has been witnessed that whenever a company announces its dividend, the price of the stock of the company fluctuates. Now to tell you why? Because the Dividend distributed among the shareholders of the company has a major impact on the price of the shares of the company. If the Dividend yield is high and the company is distributing more and more dividend among its shareholders after deducting all its cost that means the company is earning huge profit and the company has surplus money which attracts the potential investors to invest in.
Operating profit margin
The operating profit margin is in short the profit that the company makes in its daily business and not from any sale or purchase of some machinery, so this profit also has an impact on the value of shares. When a company has a high operating profit margin and is actually earning huge profits then this makes one thing clear that the company has the capacity to pay a huge dividend to its shareholders. Higher operating profit margin indicates an increase in demand for the stock which will value higher the stock prices.
Price to book ratio
No, seriously? Yes seriously, even the price to book ratio has a big impact on the value of shares. This Price to Book ratio shows one simple thing if the company gets torn up today then what will be the net worth of the company or what will be the company left with. This is a very useful technique because some companies may not be doing well in their business operations but their net worth is still high due to their high valued assets. The various assets that company has invested in during their tenure have a lot of impact on the value of the shares and a higher book value of the assets means higher net worth of the company. The higher net worth of the company also helps in building the reputation of the company and thus has a major impact on the value of shares.
Fundamental analysis is a method known for assessing the intrinsic value, economic, financial, qualitative and quantitative factors associated with the bond. It is a kind of study that analysis the value of security by determining its macro-economic and micro-economic factors. It is the most appropriate method because it analyses by blending the economic conditions of an organisation with its financial conditions. It helps an investor in comparing the current price of any security as it offers the accurate quantitative value of any asset. Moreover it also eradicates the problem of over-pricing of shares.
Fundamental analysis is a quite beneficial method for the underlying companies because it determines the financial health by obliterating the difficulties which were coming in its working. Its basic purpose is to identify those sets of companies which are fundamentally strong or those which are weak. Investors invest in the strong companies by having the belief that their proportionate amount of shares’ price will rise in the near future. While in case of short companies, they sell their shares owing to the fact that the value of these shares might fall in coming times. This method is also known by the name of security analysis because it predicts the path of prices through the study of historical data like price and volume.
The major role of fundamental analysis in a company is to investigate into the financial statements. It is also referred as qualitative analysis because it consist of revenue, expenses, assets, liabilities and other financial aspects of a company. Fundamental analysts are able to get the detailed information about the company’s future performance.
How financial analysis is executed?
Fundamental analysis includes economic, industry and company analysis. These three analysis also determine the intrinsic value of market shares.
The buyer is recommended to buy the share if its intrinsic value is higher than the market price. These analysis also helps the buyer to sell the shares if its value is less than the market price.
The process of fundamental analysis requires real, public data is estimating the value of a security. Most of the fundamental analyst use this method to evaluate the stocks. It is not only beneficial to analyst but also benefits the investors by letting them know the exact price value of the share. Fundamental analysis also allows the investor to know about the bond issuer like possible changes in credit ratings.
Top down and bottom up approaches
Top down or bottom-up approach is followed by the investors while using the fundamental analysis. The investor who thinks of top-down investing starts his/her analysis with global economics that includes both international and national economic indicators. GDP growth rates, inflation, interest rates, exchange rates, productivity and energy prices are also included in the top-down investment. Investors in this segment narrow their search to regional analysis of overall sales, price levels and foreign competition.
Whereas the investor who is investing in bottom-up investment starts with specific businesses and proceeds in opposite to the top down approach. Thus the usage of financial analysis has brought more transparency in the financial sector by eradicating the possible chances of overpricing of shares.
Financial Analysis Model
For analysing the financial health of a company, a financial analyst analysis the financial statement that consist of financial ratios. Financial statements give detailed information about paid dividends, operating cash flow, new equity shares and capital financing.
The valuation models used in the process of financial analysis determine the growth rates (income and cash) and risk levels. For calculating the present value of the dividends that can be received by the investor, a financial analyst uses the model of discounted cash flow. Even the debt that is acquired by the company is also calculated in determining its financial status. The company’s debt is also assessed by using the debt-to-equity ratio and current asset to liability ratio.
Price-to-earnings ratio is the simple common model that gives an understanding of perpetual annuity (time-value of money) to a financial analyst. It is also called as the discount rate that is accurate for analysing the risk of business.
PEG ratio is also giving unified growth estimates whose validity depends on the growth which is determined by the financial analyst. For attributing the expected changes in growth from current P/E, IGAR model’s help is required. These financial business models are also useful in presenting the quantitative value of stock’s historical growth rates in respect to comparison index.
Gone are the days when subjective interpretation of the fundamental data used to take place in companies. With advancement in technology, computer modelling of stock prices has replaced the antiquated systems of maintaining the financial balance sheets.
Benefits of Financial Analysis
Benefits of Financial Analysis
The usage of financial analysis help the company’s shareholders to get an insight about its decisions, policies and turnover. More or less, it also informs the investor about company’s total net worth. It represents the annual report of a company that consist of financial highlight, management discussion and analysis, corporate information and report on corporate governance.
Moreover it also gives a brief information about balance sheet which will consist of profit and loss statements, equity research along with business transaction details of the company.
Those set of people who are thinking of investing in the long-term projects may get benefitted from taking the help of financial analyst who can predict and tell them the right to hold the shares or sell them.
The usage of financial analysis has helped the Indian economy to get stabilized by removing the difficulties. In recent years, the usage of newly devised financial models has replaced the earlier problems like overpricing of shares and enhanced the transparency in several financial companies.