A simple question many investing beginners have is how do you value a company? Honestly there’s many different ways this can be done. But, it’s a little more complicated than just looking at the stock price. In this article I will show you how to value a company. You can find more details in Step 4 and Step 5.
Value a Company with P/E Ratio
The simplest way to value a company with one ratio is the P/E ratio. The P/E ratio of a company is shown on every finance website for stocks, and can be a great way to determine if a company is over or undervalued. P/E stands for price to earnings, and is calculated by dividing price by earnings.
There are a couple ways to do this. First you can take a company’s stock price and divide by their EPS (earnings per share) to find the P/E ratio. The EPS number is also easily found on an financial website such as Yahoo Finance. A P/E below 15 is considered a good ratio.
P/E = [Price] / [EPS]
You can also calculate P/E ratio from the net earnings number. This involves finding out how many shares outstanding there are and calculating the market capitalization of the company. This is the reason why you can’t just take a company’s share price and determine from there if it is expensive or cheap. Every stock has a different number of shares, so the total value of a company depends on the market capitalization and not the share price.
The P/E ratio is great, but it doesn’t tell the whole picture of a company. It’s often important to combine this ratio with another, to truly understand the value. The other popular valuation to value a company is the P/B ratio.
P/B Ratio for a Better Picture
The P/B ratio stands for price to book ratio, and can tell a better picture than P/E ratio in some cases. When both valuations are combined, you determine a much better value for a company. The P/B is much less volatile than P/E ratio, and is therefore more stable. A company with a low P/B has much more assets than liabilities, and is relatively cheap. The lower the P/B ratio, the greater of a discount you are getting to essentially buy this company’s assets.
P/B ratio is calculated by dividing price by book value. Price in this case is referring to market capitalization, and book value is shareholder’s equity (total assets minus total liabilities).
P/B = [share price * shares outstanding] / [total assets – total liabilities]
If you are looking for more insight and analysis on these two ratios be sure to check out Step 4 and Step 5. Or, if you are starting out in investing I recommend starting from Step 1, which is an inspiring post about the great possibilities in investing.
I hope you enjoyed the information in this post. Please leave a comment if any of my work has helped you in your learning. I wish the best to you all.
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**How Do You Value a Company – Wisdom Wednesdays #8**
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