The value of stocks and shares can be influenced by a wide range of factors. Being able to pin down an accurate number is crucial to the success of any potential investment. Knowing when shares are overpriced can save you a lot of money and knowing which are undervalued could make you a lot more. These four basic tips can help you along the road to a greater understanding of how stocks and shares are valued so you can invest your money more wisely.
1. P/E ratio
The P/E, or price-to-earnings ratio, is the bread and butter of basic stock valuations. The ratio is calculated by dividing the stated share price by the most accurate estimation of earnings per share. Theoretically, a lower ratio is representative of a better potential investment, but you need to know the ratios of other similar share offerings to ascertain its relative worth.
Earnings can, of course, fluctuate. Therefore, the P/E ratio is also subject to change. It is for this reason that further investigation should always take place before making a significant investment. The earnings per share can normally be found on most finance sites and are based on the money made by the company over the most recent 12 months of trading.
2. P/B ratio
The P/B, or price-to-book ratio, is calculated by comparing the list price with the company’s overall value, which is known as the book value. The P/B ratio is also sometimes known as the price-equity ratio. To calculate the book value, a company’s intangible assets and liabilities must be subtracted from its total assets.
Divide the market price per share by the book value per share to ascertain the P/B ratio. As with the P/E ratio, a lower number is often indicative of an undervalued stock. However, another possible cause of a low P/E ratio is that the company itself is in poor health, so it isn’t enough to justify an investment without further research.
3. P/E growth
The P/E growth ratio is used to estimate the growth rate of a stock or share price by accounting for the company’s earnings. To calculate the figure, the P/E ratio is divided by the rate at which a company’s earnings increased over a set period of time. A low PEG ratio may indicate an undervalued stock and a good investment.
However, being based on the P/E ratio, it shares a lot of the same strengths and weaknesses. Namely, the figures used in the base calculations are subject to change. Even so, the PEG ratio is often considered a better tool for providing a more well-rounded and useful figure than the P/E ratio it’s based on. If applied appropriately, the PEG ratio can be a great indicator of true share values.
4. Dividend yield ratio
Divide an annual dividend amount by the initial share price to calculate the dividend yield ratio. A higher ratio, the better the return on investment you may receive. For investors looking to make their money from dividends, calculating the yield ratio is absolutely essential. A high return from a low investment is highly attractive but may leave little room for growth.
The highest dividend yield ratios can generally be found in companies that are well established in their industries and are financially matured. They can be a smart investment for anyone seeking a stable return on their money over a longer period of time. However, due to the nature of the calculation, the yield ratio will only increase as a share price falls and a drastically falling share price is often quickly followed by cuts to the dividend.
Generally, a sound understanding of stock and share prices necessitates the application of several different analysis methods. Any single calculation can easily paint a misleading picture of share value, so it’s essential you research your investments as dutifully as possible. If you do, you’ll be able to commit your money with the confidence that you’ll see a significant return on investment.
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