Stock Valuation – How To Value A Company

Stock Valuation – The Relationship Between A Company’s Stock Price and Cash

In another article titled Companies To Invest In, I made the point that, at its core, a well-run company is simply a money making machine.  That concept – that the value of a company is ultimately tied to cash – is one of the keys to understanding how to value a company and it’s relationship stock price.  Stock valuation are great to get quick snapshot of a company’s value.  I’ll illustrate this point with a simple example, and then build on it in ensuing articles.

How To Value A Company – Cash Per Share Example 1

If there were a company that had $1,000 in cash with 100 shares of stock outstanding then you could calculate the value of each share of stock as follows.

Stock Valuation Cash Per Share Example

How To Value A Company – Acquiring 20% Ownership Example 2

If that were the case and you wanted to own 20% of the company then how much stock would you have to buy, and how much would it cost?  The answer is that you would have to pay a total of $200 for 20 shares of stock, which can be calculated as follows.

Stock Valuation Ownership Example

How To Value A Company – 10:1 Stock Split Example 3

What if the company did a 10 for 1 stock split, meaning instead of having 100 shares outstanding, it had 1,000 shares outstanding?  Would that change the value of the company?  The answer is no.  The company’s only asset is $1,000 of cash, and no amount of stock splitting (or combining) can change that.  However, by doing a 10 for 1 stock split the value of each individual share is diluted, going from $10 to $1 per share.  So in summary, a stock split affects the value of each share of stock, not the value of the company itself, which can be illustrated as follows.

 

Stock Valuation Stock Split Example

 

Now, what if our little company went public and was traded on the New York Stock Exchange?  Wow, that’s big time!  Wouldn’t that would boost its stock price above the $1 it’s now trading at after the stock split?  Not at all!  The stock could be traded on the moon, and that still wouldn’t alter the fact that the total assets of the company are worth $1,000, making the value of each of those 1,000 shares equal to $1.

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How To Value A Company Using The Terminal Valuation Method

But wait, isn’t just focusing on a company’s cash overly simplistic?  After all, there’s no company of any size or consequence whose only asset is cash.  While that may be true, at the end of the day, determining how to value a company is ultimately measured in money (or cash) – nothing else.  This is known as the terminal value of a company.

The application of this concept is known as the Terminal Valuation Method.  To illustrate how it works, say a company’s stock price is trading at a value that suggests the total worth of the company is $10,000,000.[1]  How can you tell if this stock valuation is reasonable?  One way to go about it is by to pretending that the company sold everything off: its inventory, furniture and fixtures, real property, and so on, until it converted all of its assets to cash.  After going through exercise you estimate that upon liquidating all of its assets and settling all of its outstanding debts (or “liabilities”) that the company would end up with $4,000,000.

“It’s Important To Note Stock Valuation Can Vary Greatly Depending On A Number Of Factors Such As: Industry, Maturity Level of Company, Ect.”

What…$4,000,000?  Didn’t we say that the value of the company’s stock suggested that it was worth $10,000,000?  Does this mean that the company’s stock price is vastly over inflated relative to its true worth? Perhaps, but not necessarily.  For example, aside from tangible assets (assets that you can touch) that could be converted into cash, an established company might have valuable intangible assets that would substantially contribute to its ability to make money: established business relationships, a highly skilled workforce, an efficient supply chain, secret formulas and patents, widely recognized brands and trademarks, etc.  In short, there can be a lot more to the value of a company than just its “hard assets” such as cash, inventory, property, etc.

However (and this is a BIG however), if a company is being valued at $10,000,000 and yet it would only be worth $4,000,000 upon liquidation, there still has to be a financial explanation for where that remaining $6,000,000 of value is coming from.  In other words, what is it about the company that makes it worth more than sum of its tangible assets?  If there is a compelling story there – a story that explains how the company’s business prospects, activities and operations are worth an extra $6,000,000 – then the stock valuation of the company can be justified.  If not then the company’s stock price is being pumped up by hype and hot air.

Summary

While it’s true that you cannot you cannot fully measure the value of a company based on its hard assets (cash, inventory, buildings, etc.), it’s also true that a company’s value is ultimately measured in dollars.  That means when it comes to a company’s stock valuation, cash is king!

 


[1] This would be the case if, for example, a company’s stock was trading at $50 a share and there were 200,000 total shares outstanding ($50 x 200,000 shares = $10,000,000).

Actively Managed Funds Vs Index

Actively Managed Funds vs. Index

Index Funds Consistently Outperform Actively Managed Funds

A recent survey once again shows what has long been the case, that index mutual funds consistently outperform actively managed mutual funds (see below).  So if that’s the case then why do so many people invest in actively managed funds?

5 Common Reasons People Fall For Actively Managed Funds

Reason #1 – Ignorance

Some people simply do not understand the long-term performance of index mutual funds handily beats that of actively managed mutual funds.

Reason #2 – Sales Efforts

Firms make much more money off of actively managed mutual funds, often 1%-2% of principle per year vs. 0.18%-0.25% for many index funds.  As a result firms put relentless efforts behind selling actively managed funds (with great success!)

Reason #3 – Greed/Temptation

By definition you can’t beat the market if you’re in an index fund designed to mirror the market.  What are you, some kind of wimp?  And so people pour billions into actively managed funds only to see their returns lag year after year.

Investor Pride – This is a close cousin of “greed/temptation.”  Here’s how the story goes.  Yes, there are lots of lousy actively managed mutual funds out there, but by virtue of your penetrating insight you are smart enough to pick a fund that will beat the market…and that’s how the train wreck begins.

Reason #4 – Fund Manager Pride

So despite the sub-par performance of actively managed funds, show me one that doesn’t have a fund manager that thinks they can be the market every year.  If you can find one then I would love to see what the marketing material looks like, “Invest with us – we guarantee we’ll charge you more and underperform relative to the market in the process!”

Reason #5 – Performance Chasing

Maybe you’ve had a reality check and realize if you’re like most regular you can’t consistently beat the market (but don’t worry, the pros can’t either).  But wait, you don’t have to be smart enough to beat the market, right?  You’ll just find some mutual fund rankings and pick the ones that performed the best last 1-3-5 years, right?  That’s called performance chasing, which is another name for buying high and often selling low (instead of the other way around!).

Low Cost Index Funds are the Best Long-Term Investment Strategy

So what’s the solution?  What’s a good investment strategy for regular people?  Unless you’re able buy stock or another investment at an amount that’s comfortably below the market price (such as pre-IPO stock) then you’re best bet for the long-term is to invest in low-cost index funds (view Best Vanguard Funds for specific recommendations).  It may not get you riches anytime soon but hey, slow and steady worked out pretty well for the tortoise!

Financial Resources For Improving Your Financial Situation

Managing your funds well throughout these times is of utmost relevance. Individuals are having a hard time making ends consult the raising cost of products as well as the rising interest prices on home mortgage as well as vehicle findings- the honest truth that a number of companies, and economic titans at that, are either folding or minimizing workers.  You can improve your financial situation greatly by using the right financial resources.

Much uncertainty waits for the air in today’s financial scene triggering the need for useful finance assistance not simply for huge financiers yet right to typical individual trying to endure the day-to-day grind. It would certainly seem like employing an individual economist to help you make likelihoods and ends of your present situation would certainly be pricey as well as can perhaps lower your readily available financial sources likewise even more down.

Financial Resources Suitable for Road to Your Economic Success:

Stock Profit Calculator

Stock Profit Calculator That Allows You To See Different Scenarios

First is investments.  There is no warranty that you’ll generate cash from investments you make. Yet if you obtain the basic realities about saving as well as investing and also adhere to using with an intelligent plan, you should certainly manage to obtain economic security as well as safety and security for several years and also indulge in the benefits of handling your money.

No individual is birthed recognizing exactly how you could conserve or to invest. Every effective investor starts with the essentials. A few individuals might stumble into economic protection – a wealthy loved one might die, or a business may eliminate. For great deals of people nonetheless, the only technique to obtain financial protection is to conserve as well as invest over a lengthy amount of time.

Discover if there is any money that could be spent. If so, then consult with financial resources such as an investment broker to check out if precisely what you need to invest is worth the trip. If it is large as well as it is put appropriately, then perhaps there will certainly suffice to use towards your retirement.

When you obtain your entire ducks right, make sure your tax obligation lawyer or accountant realizes your complete monetary development. They can assist you much better plan for the future by recognizing where you go to the present moment. They can additionally supply you some terrific recommendations relating to the very best ways to proceed in your investments.

Time and again, individuals of also moderate means which begin the quest reach financial security and also all that it assures: buying a home, academic chances for their children, as well as a comfy retired life. If they could do it, so might you.

Savings & Budgeting

Second of all is making to get just your basic needs as well as save as much of your incomes as you can. Include your cost savings in your regular monthly budget strategy. It is likewise a good idea to examine your investing methods and also you will be able to check out where you need to make decreasing or you could possibly source for an additional income. If you use bank card, it is very important to manage your investing. They are hassle-free yet at the same time they can land you into a stack of monetary difficulty.

It is vital that you entirely realized just exactly how it works to make sure that you could utilize it appropriately. If you acknowledge that you could not have the discipline as well as you put on not would such as to carry cash around, you can go with a debit card. It functions merely like cash and has a limit relating to simply just how much you can invest.

How to Invest in Stocks

Learning How to Invest in Stocks 101

Regardless of how many Wall Street films you have seen in the past, stocks and shares is not an easy topic. Those who are searching online for resources on how to invest in stocks for beginners or with little money thinking that they will “certainly” become the next overnight millionaires should, first and foremost, receive a word of warning: Yes, some people can really get rich overnight playing with shares at the stock exchange market; however, but that happens once a blue moon. Every person willing to dip a toe in the world of stocks investment should, at the very least, get prepared first and —as if you were playing chess— think his moves twice beforehand to prevent regrets after.

That being said… How to invest in stocks?

First Things First: Get Informed

Stock Profit Calculator

Stock Profit Calculator That Allows You To See Different Scenarios

Before spending one penny in a stock market, the first thing you should do is to get informed. Let’s ask a few questions so you can ask yourself if you know the answers:

  • Do you know what a stock is, and how they are currently stored?
  • How many kinds of shares are there, and which of them you can buy?
  • Do you know what a stock broker is? Have you found any for yourself already?
  • Lastly, have you spoken with your accountant about the financial and tax consequences (if any) of becoming a stock investor?

If you do not know the answer to any of these questions, then please let me suggest you the following readings:

  • Investing articles on stocks and the stock market could be a reasonable starting point.
  • The Beginners’ Guide to Investing, by the American Securities and Exchange Commission can provide you a more specific introduction to the topic.
  • Investor’s glossary page can help you clear your doubts.
  • Lists of stock brokers such as this one by Nasdaq can help you find a reputable stock trader for your assets.

Learning How to Invest in Stocks

Next, choose how you will invest in stocks

Once you have covered the basics and feel better informed to start investing, you need to find out a way to do it suitable for yourself and for your money.  There are many options and approaches for this, yet, for beginners, I like to keep things simple. Remember the goal is to make money, and that you have basically two ways to get it with stocks:

  • You either buy stocks to resell them after a short time.
  • You buy stocks to expect a profit sharing payment or resell them after a longer term.

In both cases, your goal will be to make more money from what you invested, a profit.

What are the best stocks to invest in?

The best stocks are on companies or markets you understand, so this answer will depend strongly in your background. Let’s try to make it clear with an example, anyway:

Let’s say someone offers us stocks from an ice-cream company… would you buy them? An uninformed person may go buy them just because “heard” those shares are “about to go up”, and that “it is the exact moment to buy them.” Someone who understands the ice-cream market, however, would pause for a moment and think: Ice-creams are mainly sold in summer. During the winter, their demand falls down. The wisest move would be to buy the stocks in winter, when demand is low and prices go down; and to sell them in spring or at the beginning of summer, when demand goes up and so do prices.

After learning how to invest in stocks, remember knowing the market you are about to invest in will help you get a better understanding of when to buy or sell your stocks.

Certainly, your stock broker should advise you about your investments too.

Fidelity Active Trader Pro

Fidelity Active Trader Pro

Understanding how to use the Fidelity Active Trader Pro will make your life so much easier.  On top of that, you’ll be able to quickly find what you’re looking for.  In this article I’ll review Fidelity’s Active Trader Pro Platform in addition to showing you some of the features.