Stock Valuation Methods: Complete Guide for Investors

Investing in stocks requires you to do a proper and detailed analysis to ensure that you are making the right call. Starting from analysing the stock market, global situations, the economy, to the company, every detail needs to be taken care of. But that is not it. There are certain stock valuation methods as well to consider. 

Trading and investing are not as easy as they sound. It is incomplete until you know how to evaluate stocks properly. This is not just linked to determining the market value. But if you want to invest right, you must know the intrinsic value of the stock that you plan to invest in. This applies to every stock listed on the stock exchange. 

Now, the question here is, what is stock valuation exactly? Well, if you are eager to know the stock valuation methods with examples, then read this guide. Explore all the details you need and start investing right.

What Is Stock Valuation?

Stock valuation is the process of finding the fair value of a company’s shares. It is the method that you use to decide on the buying and selling of the stock well. It can also guide you on which stocks to hold and which you must close the deals on. 

You look at factors like earnings, assets, cash flows, growth potential, and risks. This all helps you to estimate what the share should ideally trade at. By focusing on all the aspects, it ensures that you make the right call. 

In stock valuation, you calculate the intrinsic value of the stock. This value shows what the share is truly worth based on real numbers and future expectations. It removes the noise created by market news and short-term price moves.

This value is compared with the market value, which helps with the decision. This is done as follows:

Types of Valuation of Stocks

Stock valuation is divided into two broad types. Each type uses a different approach to find the fair value of a stock. The details of the same are as follows: 

1. Absolute Valuation

Absolute valuation finds the stock’s true worth. As the name suggests, this method uses only the data that is based on the actual company reports. In other words, it uses the company’s own financial data. 

It studies earnings, dividends, cash flows, assets, and growth. It does not compare the company with others. Under this, the general models that are used are like DCF and dividend-based valuation. The entire focus here is on the company and nothing else. 

2. Relative Valuation

Relative valuation compares a company with similar companies in the same sector. It helps you to understand whether the company you are planning to invest in is working better or poorer as compared to the rest of the companies.

It checks this with the help of various market ratios. Some of the common methods that are used are P/E, P/B, EV/EBITDA, and P/S. This helps you to evaluate the numbers and see the actual performance against the competitors for clearer decision-making.

Methods of Valuation of Stocks

Valuing a stock becomes easier when you follow structured methods. This ensures that you consider the right values and numbers to bring in the actual value of the stock. Some of the most common methods of valuation of stock are as follows:

1. Dividend Discount Model

This method values a stock based on the present value of future dividends. It works only for companies that pay regular and predictable dividends.

Example: If a company pays a steady dividend of Rs. 6 each year and the required return is 9 percent, the fair value comes to about Rs. 66. If the stock trades at Rs. 55, it may be undervalued.

2. Discounted Cash Flow Model

This method finds the intrinsic value by discounting. This is based on considering all expected future free cash flows. It works well for companies that do not pay stable dividends.

Example: Say, there is a company that generates Rs. 20,000 in free cash flow each year. This is the track record for five years. Now, you discount it at 10%. Now, the total present value becomes the fair value. If this value is higher than the market price, the stock may be a good buy.

3. Comparable Companies Analysis

This method compares a company with similar companies in the same industry. So, the method here is to use the financial ratios for the analysis. Now, there are many ratios that you can use here, but only a few of them are proven to be effective.

Here are the most common ratios used:

• Price to Earnings (P/E): Compares the stock price to earnings. Lower P/E than peers may show undervaluation.

• Price to Book (P/B): Compares price to net assets. Helps judge asset-rich companies.

• EV to EBITDA: Shows how the market values operating earnings. Useful for capital-heavy sectors.

• Price to Sales (P/S): Compares price to revenue. Works well for early-stage companies.

• PEG Ratio: Adds growth to valuation. Helps judge whether a high P/E is justified.

Example: If peer companies trade at an average P/E of 18 and your company has an EPS of Rs. 20, the fair value becomes Rs. 360. If the stock is trading at Rs. 290, it may be undervalued.

Conclusion

Stock valuation helps you cut through noise. This allows you to focus on a company’s real worth. By using methods like the Dividend Discount Model, the Discounted Cash Flow model, and comparable company analysis, you get a clearer view. This helps you to make the call on whether a stock is priced right.

Each method works in different situations, so using a mix of them gives better clarity. With steady practice, you can make decisions with more confidence. This also helps you to eliminate the hurdles that impact the decisions. 

So, start your investing journey with Rupeezy. Make smart decisions and ensure that your investment grows.

FAQs

What is the main goal of stock valuation?

The goal is to find the fair value of a stock so you can decide whether to buy, hold, or sell.

Which valuation method is best for beginners?

DCF and P/E-based comparisons are simple for beginners because the inputs are easy to understand.

Do all companies fit into dividend-based valuation?

No. DDM works only for companies that pay steady and predictable dividends.

Why is comparable analysis popular?

It is fast, simple, and helps you judge a stock by comparing it with similar companies.

Can valuation guarantee profits?

No. Valuation improves your decision-making, but market risks still exist, so planning matters.