A primary “goal for management is to maximize the current value of the firm’s stock” (Parrino, Kidwell, Bates, 2012, pg. 12). As a result, understanding the true value of stock is beneficial. Stock valuation is important to identify which stocks are more desirable and will maximize wealth. Since stock has an effect on business and one’s own portfolio, valuing stock is critical. Several methods to value stock exist however; there is no best method for this valuation. Each stock contains its own characteristics to analyze based on the company issuing it. One must analyze the business and stock to find the ideal stock valuation method. By comparing the market price of stock to the realized value in the stock valuation, one can determine whether a certain stock is the optimal choice. The stock market is typically used for the trading of stocks that are listed and available for the public to buy or sell. These stocks are a part of shared capital in a specific company. As such, it gives the investor the power to own and make decisions regarding the company’s operations.
In return the management ensures that they increase the value of the capital investments through different strategies that maximize profits. The success of this strategy will create a surge in demand of a particular stock increasing the market price while the contrary will create a decline in the market price value. The commonly used analysis by both the market and investors to understand or rate a stock is the price/earnings, or PE, ratio. It exemplifies the current price of a stock divided by a company earned for every share outstanding over the past year. When the PE ratio rises above the benchmark level, the investors are optimistic of the company’s earnings per share to rise. However, a low P/E ratio often means the market expects earnings to fall, which could trigger a decline in the stock price.
Dividends are also used to value a stock by both investors and the market with a positive expectation or declaration increasing the demand of a stock. The expectations are set by the specifics of a stock with the preferred stock option having a definite dividend payout within a timeframe. The common stock will only earn dividends if the company makes profits and the board of directors declares the amount to be paid, which could vary periodically. After the declaration of the dividend amount by the company’s’ board of directors, stock prices will continue to rise till the ex-dividend date. The Ex-dividend date is the last date on which you can buy the stock and be able to receive the dividend, which accelerates the demand whereas the stock price will fall after the payout of dividend.
The stock market is big business. Trillions of dollars are invested in the market, and millions of people and businesses are hoping that their investment is a wise one. The savvy investor is one who knows how to value a stock to make sure that the business they are investing in has the core fundamentals in place to provide a good return on their stock investment. Some people look at various ratios to see if the metrics are in place. Some people look for good dividend payouts. There really is no limit to the different things that investors can look for in a stock to help in a buying decision, but at least some things have been shown over time to be benchmarks of profitable stock decisions. It certainly beats the alternative of knowing nothing about a company and “just throwing a dart at the wall and hoping it sticks someplace good”.
Parrino, R., Kidwell, D. S, & Bates, T. W. (2012). Fundamentals of Corporate Finance (2nd ed). Hoboken, NJ: Wiley.