Ways to Calculate Share Price
After a company's stock begins trading on the market, the company doesn't set the price for it. Rather, investors determine estimates on how profitable they believe holding shares of a company will be for them, and market prices reflect the free-market consensus on the potential earning power of their investment. Investors use a number of valuation formulas when setting target prices to purchase stocks. Despite valuation methods, a stock's price is merely a tool that indicates how much revenue a stock's dividends are expected to pay.
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Price/Earnings Ratio
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The price/earnings, or PE, ratio is a simple valuation tool that allows investors to determine how many years it will take to recoup their investment in a company's stock. To calculate a stock's PE ratio, investors divide its current market price by its latest dividend. For example, a stock that sells at $100 a share and provides $20 in dividends to investors each year has a PE of 5. Although average PEs vary among industry sectors, they're typically between 15 and 25. If a stock's PE is below the average for its industry, it could be undervalued, causing its market price to rise accordingly.
EBITDA
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Another tool to examine the earning potential, and therefore price, of a company's stock is to consider its raw cash flow, or its earnings before interest, taxes, depreciation and amortization, also known as EBITDA. This measure is useful in evaluating the profitability of companies that face significant startup or reinvestment costs that may skew other types of analysis. By focusing only on a company's cash earnings, dividing the price of outstanding shares by its cash flow, an investor may develop an EBITDA multiple to represent a ratio of price to cash flow. If a company's EBITDA multiple is lower than that of others in its industry, its stock may be undervalued, causing the price to increase.
Earnings Per Share
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Earnings per share, or EPS, is an important valuation tool that investors use to project a company's entire earnings if none were reinvested and all earnings were distributed to shareholders. To determine a company's EPS, investors subtract the dividends provided to preferred stock --- prime stock that's insulated from losses due to hierarchies of corporate dividend structure --- from the total earnings for that period. This figure is divided by the average number of outstanding shares during the reporting period to determine EPS. Although EPS doesn't tie directly to dividend reporting, it's an indicator of the overall profitability of a company.
Stockholder Equity
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Shareholder equity is another means investors use to determine the value of a stock. Similar to EPS measures, shareholder equity divides the total worth of a company's combined holdings, minus debt and other obligations, by the total number of outstanding shares. Although this measure doesn't indicate if a stock with a high price will provide a strong return on investment, it indicates the capital invested in the company and, in the case of liquidation, an investor's final return.
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