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Encyclopedia > Stock valuation

There are several methods used to value companies and their stocks. They attempt to give an estimate of their fair value, by using fundamental economic criteria. This theoretical valuation has to be perfected with market criteria, as the final purpose is to determine potential market prices. Definition Fair value, also called fair price, is a concept used in finance and economics. ...

Contents

Fundamental criteria (fair value)

The most theoretically sound stock valuation method is called income valuation or the discounted cash flow (DCF) method, involving discounting the profits (dividends, earnings, or cash flows) the stock will bring to the stockholder in the foreseeable future, and a final value on disposition. The discount rate normally has to include a risk premium which is commonly based on the capital asset pricing model. It has been suggested that this article or section be merged with Net present value. ... A risk premium is the minimum difference between the expected value of an uncertain bet that a person is willing to take and the certain value that he is indifferent to. ... An estimation of the CAPM and the Security Market Line (purple) for the Dow Jones Industrial Average over the last 3 years for monthly data. ...


The Gordon model or Gordon's growth model[1] is the best known of a class of discounted dividend models. It assumes that dividends will increase at a constant growth rate (less than the discount rate) forever. The valuation is given by the formula: Gordon growth model is a variant of the discounted dividend model, a method for valuing a stock or business. ...

P = Dcdotsum_{i=1}^{infty}left(frac{1+g}{1+k}right)^{i} = Dcdotfrac{1+g}{k-g} .

and the following table defines each symbol:

Symbol Meaning Units
 P  estimated stock price $ or € or pound
 D  last dividend paid $ or € or pound
 k  discount rate  %
 g the growth rate of the dividends  %

[1] It has been suggested that ex-dividend date be merged into this article or section. ...


The P/E method is perhaps the most commonly used valuation method in the stock brokerage industry. By using comparison firms, a target price/earnings (or P/E) ratio is selected for the company, and then the future earnings of the company are estimated. The valuation's fair price is simply estimated earnings times target P/E. This model is essentially the same model as Gordon's model, if k-g is estimated as the dividend payout ratio (D/E) divided by the target P/E ratio. In finance, the PE ratio of a stock (also called its earnings multiple, just multiple, or P/E) is calculated as: The price per share (numerator) is the market price of a single share of the stock. ...


Market criteria (potential price)

Some feel that if the stock is listed in a well organized stock market, with a large volume of transactions, the listed price will be close to the estimated fair value. This is called the efficient market hypothesis. In finance, the efficient market hypothesis (EMH) asserts that financial markets are informationally efficient, or that prices on traded assets, e. ...


On the other hand, studies made in the field of behavioral finance tend to show that deviations from the fair price are rather common, and sometimes quite large. Economics Nobel Laureate Daniel Kahneman, was an important figure in the development of behavioral finance and economics and continues to write extensively in the field. ...


Thus, in addition to fundamental economic criteria, market criteria also have to be taken into account market-based valuation. Valuing a stock is not only to estimate its fair value, but also to determine its potential price range, taking into account market behavior aspects. One of the behavioral valuation tools is the stock image, a coefficient that bridges the theoretical fair value and the market price. Market-based valuation is a form of stock valuation that refers to market indicators, also called extrinsic criteria (i. ... This is a disambiguation page — a navigational aid which lists other pages that might otherwise share the same title. ...


See also

Active management (also called active investing) refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming a benchmark index. ... What follows is a list of over 250 Wikipedia articles on finance topics. ... An estimation of the CAPM and the Security Market Line (purple) for the Dow Jones Industrial Average over the last 3 years for monthly data. ... Definition In economics and finance, the Value at risk, or VaR, is a measure used to estimate how the value of an asset or of a portfolio of assets will decrease over a certain time period (usually over 1 day or 10 days) under usual conditions. ... Fundamental analysis of a business involves analyzing its income statement, financial statements and health, its management and competitive advantages, and its competitors and markets. ... Technical analysis is the study of past financial market data, primarily through the use of charts, to forecast price trends and make investment decisions. ... The Fed model is a theory of equity valuation thought to be used by the Federal Reserve that hypothesizes a relationship between long-term treasury notes and the market return of equities. ...

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Stock Valuation
Trading Theories: Dow Theory | Elliott Wave Theory | Fundamental analysis | Technical analysis
Mark Twain effect | January effect | Efficient market hypothesis
Stock Pricing: Dividend yield | Gordon model | Income per share | Book value | Earnings yield | Beta coefficient
Ratios: Financial ratio | P/CF ratio | PE ratio | PEG ratio | Price/sales ratio | P/B ratio
Stock Related Terms
Dividend | Stock split | Growth stock | Investment | Speculation | Trade | Day trading

  Results from FactBites:
 
Stock Valuation Methods (2547 words)
This form of valuation is based on historic ratios and statistics and aims to assign value to a stock based on measurable attributes.
Stock B is trading at a forward P/E of 30 and expected to grow at 25%.
The PEG ratio for Stock A is 75% (15/20) and for Stock B is 120% (30/25).
  More results at FactBites »

 
 

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