How to Value Common Stock

Value of common stock

Common stock is a type of stock in which owners own a share, or multiple shares, of the company in which they buy stock. Common stock investors make money in two main circumstances - when the company pays dividends to it's stockholders based on the companies earnings. Owners of common stock investors can also realize a profit when they sell there shares at their market value assuming that the value of the stock has gone up. There are also different ways to value common stock. It's important to figure out the value of common stock if you are considering purchasing any. Read on to learn how.

Instructions

1. The first way to figure out the value of common stock is to use the present value of future dividends. In this case, the present value of the stocks would equal future dividends divided by the required rate of return. For example, let's pretend that a company pays an annual dividend of $4 per share, and required rate of return is 13%. To find the present value of this common stock, you would divide 4 by .13. The value of this stock would be $30.77.

2. Another way to value common stock is by looking at something called free cash flow. Free cash flow is the cash that is generated by a business' operation less their capital expenditures. Basically, free cash flow is the money that a company has available after all of their bills have been been. When using this method, the basic formula used to find the value of the common stock is the free cash flow per share divided by the required rate of return. For example, say that a company had free cash flow of $5 per share and the required rate of return is 13%. The present value of this stock would be $38.45.

3. A third method that can be used to figure out the value of common stock is more complex than the other methods. You need to look at two things - the current activities of that stock and the value of growth opportunities.

4. To figure out the current activities or earnings, you will need to have the earnings per share of stock, also called EPS.

5. You will also need to find out the value of growth opportunities for the stock, which is also referred to as PVGO, present value of growth opportunities. To find the PVGO, you will need to know the last dividend that the company paid to stockholders and the future rate of return. For example, let's say that the last dividend paid was $1.50 and the dividend is estimated to grow each year at 4%. To find the PVGO, use the following formula: PVGO = Dividend(1 + g), with g being the estimated growth, in this case 4% or .04. Your problem would look like 1.50(1 + .04) = 1.50(1.04) = 1.56. $1.56 is your PVGO. You will need this later.

6. Once you have the these figures, you are ready to solve for the value of the common stock. First, divide the EPS by the required rate of return. In this instance, let's pretend that the EPS is $4.00 and the required rate of return is 11%. The EPS (4.00) is divided by the required rate of return (.11) to give you a total figure of $36.36

7. The next part of this calculation requires taking the PVGO and dividing it by the rate of return minus the growth, which we figured out in step 7 to be 4% or .04. Your formula would look like this 1.56 divided by .11 - .04. Now solve: 1.56/.07 = $22.28.

8. Your last step in this problem requires you to add your results from Step 5 and 6. Your final present value of common stock in this case would be $58.64

Tips & Warnings

• This information should help you to determine the value of a common stock to you, the purchaser.

• Look at other indications of how a company is performing before purchasing stock and consider seeking the advice of a professional.