Putting A Value On A Stock

Putting a value on stocks can be a very tricky thing to do. First of all you need to understand the P/E ratio. Basically you take the Price of The stock divide it by the Earnings Per share and you get the multiple that a stock carries. For instance for Google their price is $505 (price) / 7.86 (earnings per share) = 64 multiple. Now you can do this with any stock that has earnings, for instance Motorola... $22.46/1.68 = 13.37 multiple. So based on that Motorola is a lot cheaper than Google based on the multiple that you are paying for it.

There are a lot of other factors though that go into pricing a stock including revenue growth, float, and the general market condition. A big factor is the revenue (sales) growth, let's use Motorola and Google again. 36,843 million in 2005 and 31232 million in 2004 a 17% revenue gain for Motorola. Google's on the other hand was 6138 million in 2005 and 3189 in 2004 a 92% revenue gain. So you can see why Google gets such a high multiple. You have to also consider that Motorola pays a small dividend (small cash/stock amount for every stock you own) as well while Google does not pay any dividend yet. Normally the older the company the bigger the dividend as their revenue growth tends to slow and they need to give shareholders a reason to own their stock.

When valuing a stock though you should compare similar companies to try and find what value they should be at. Use the equation above and compare companies like Google vs Yahoo or Microsoft, Motorola vs Nokia is a good one as well. Try to compare companies in the same industries basically.

A note though, it depends on what stage you are in life as far as what you investment strategy is going to be. The older you get the less risky you should be, stick with high paying dividends and such, the younger you are the more risky you can be as it doesn't matter if you lose what you invested. I could go on forever about this subject it would seem so I will leave it at that. If you have any questions just let me know. I would also suggest reading "Real Money" by Jim Cramer, he is kinda a nut on TV but the book really lays it out very well. Good luck to you!


Charles P. said...

I saw this posted on Google, and see you have Cramer mentioned. I have read the book twice now, but I still don't understand what he is saying to compare it to on the S&P 500. Do you understand it, and if so, mind to dabble?

1Green Thumb said...

I think what he is saying is to compare Google or any other stock as far as revenues and net income growth to the average revenues and net income growth of the S&P 500. Then you can begin to understand why some stock can carry such a high P/E ratio (multiple). Google is growing at such a pace that people are willing to pay more for future earnings basically. Now I believe they grew at something like 88% last year, you need to compare that to the average company in the S&P 500 or a lot of other companies out there and it just blows them away... the question is can they keep it up. I believe that the analysts are predicting them to grow next year at 33% and this is what they are basing there future P/E ratios on. They may be right or they may be underestimating them. So you have to need to find stock out there that no one knows about that had nice revenue and net income growth that carry a small P/E hopefully and even have a small float (number of shares available to trade). So what he is saying basically is that these growth rates and such are a good way to measure up stocks to see if they may be worth owning. There are many other things to take into account as well, but the number don't lie. I hope this helps a bit...

Your Journey Begins Here