If you are in business, you might be curious as to what the basics of a stock valuation are. A stock valuation is something that the investors need when they are looking at buying shares in a company. Stock refers to the shares that a company has listed on the stock market and how much those shares are worth. There are a few formulas that are used in the valuation of stock, but usually a registered valuation consultant gets called upon to perform this job.
When the stock gets valued, it gets looked at for what it is. Not every valuation formula is going to suit every type of stock, because the value of the stock will vary from sector to sector. Different things will also influence different stock prices.
It’s all down to the formulas
Here is a brief breakdown of some of the formulas that are used in a stock valuation and how they work:
- The Dividend Discount Model (DDM). This is one of the most popular models that valuation consultant use when they are doing a stock valuation. This formula looks at how much the company pays its shareholders in dividends to ascertain its true value. The reason that it uses the dividend method is because the logic is that dividends should be stable and predictable after a while, meaning that the company is always making a decent amount of money. The dividends get averaged out each year to show growth. This is one way in which shares and stocks can get valued, as it lets the potential investors know exactly how much they should be expecting to get. From there they can decide if they are happy with the numbers or not.
- The Discounted Cash Flow Method. This method is more commonly used on companies that do not pay dividends or who pay them irregularly. This model is based on free cash flows and terminal values. If the company’s free cash flow is stable and one can see a pattern of projected growth for a while to come, one can then calculate a terminal value, meaning that one can say ‘at this point in time, company X with be worth Y’. Based on this, the value of the stocks are calculated.
These are two of the most commonly used stock valuation methods that are used on the market today. If you get a stock valuation done, it would be good to make sure that you understand how these work in depth, so you don’t get told misinformation.
