How to Create a Stock Valuation

Before investing in a particular stock, an individual should endeavor to know what they should pay for the stock. A person would not purchase an appliance or car without doing the proper research on price, but that is what happens when an individual purchases a stock without creating a stock valuation. When an investor creates a stock valuation it gives him the price he should pay for the stock. Here is how to create a stock valuation.

Instructions

1. Select the measurement of the stock that you consider most relevant to its value. If you believe profit is the best determinant of value then the price to earnings ratio may be your best option. If equity return is what you want then dividend yield may be the correct measurement tool to determine valuation. Whichever you choose be sure you consider how the figure or ratio is relevant to the value of the stock.

2. Choose a few stocks on which to apply the valuation tool. You can use software that will analyze the entire market but for the purposes of this example, you need to choose a few stocks and measure their value.

3. Determine the sector average of the valuation measurement tool. In this example, we are using the price to earnings or PE ratio. You can find the sector average of the PE ratio at most any financial website (such as Yahoo! Finance or Bloomberg). The sector PE ratio is important because it tells what the average company's PE ratio is and gives you a means to compare other stock against this average. See the resources section for more information.

4. Ascertain the PE ratio of each stock you want to know the value of. Again, most every financial web site lists this information for each individual stock. Take the earnings of the company then divide that number by the amount of shares outstanding to get earnings per share. Now divide the price of a single share of stock by the earning per share to get the PE ratio. See the resources section for more information.

5. Compare the PE ratio of the individual stock to the industry average to determine if the stock has the best profits relative to other similar stocks.

Resources

• Sector information
• Finance link