A Beginners Guide to Online Share Valuation

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A Beginners Guide to Online Share Valuation

Disclaimer: The content provided in this blog is for informational purposes only and does not constitute financial advice.

Online share valuation is crucial for intelligent investing. Regardless of whether you are a novice investor or a seasoned pro, understanding how to value shares is essential to making informed investment decisions. This guide will explore the basic concepts and methodologies of online share valuation to simplify this key component of investing.

Basic Concepts of Share Valuation

At its core, share valuation refers to the process of determining the intrinsic value of a share in a company. This intrinsic value is the true, underlying worth of the share, independent of its current market value. It sheds light on whether a share is overvalued or undervalued, guiding investors on when to buy or sell shares.

Fundamentals of Online Share Valuation

  1. Earnings Per Share (EPS): The EPS is calculated by dividing the profitability of a company by the number of outstanding shares. If a company’s EPS is high, it hints at higher profitability.
  2. Price to Earnings Ratio (P/E ratio): The P/E ratio is the ratio of a company’s share price to its per-share earnings. A higher P/E ratio could signify an overvalued share, whereas a lower P/E might indicate an undervalued share.
  3. Dividend Yield: Dividend yield is the annual dividend payment divided by the share’s market price. Higher yields are typically a sign of stock undervaluation.

Investors commonly utilise these three financial indicators in tandem to paint a comprehensive picture of a share’s valuation. Understanding the stock market and how it works is vital in interpreting these indicators precisely.

Woman valuing shares online

Methods of Share Valuation

Making sense of which shares to purchase or sell necessitates a thorough grasp of share valuation methods. These methods fall into two primary categories: absolute and relative.

Absolute Valuation Methods

Absolute valuation methods aim to establish the intrinsic value of a share. These techniques involve detailed financial forecasting and usually incorporate the ‘time value of money’ concept. Following are the major absolute valuation models:

  1. Discounted Cash Flow(DCF) Model: This model makes use of a company’s future free cash flow projections and discounts them to arrive at a present value estimate, which is then used to evaluate the potential for investment.
  2. Residual Income Model (RIM): RIM focuses on the residual income, which is the net income an investment produces over a given rate of return. The end goal is to determine whether the intrinsic value of a share is more than the book value.
  3. Dividend Discount Model (DDM): Essential for income-focused investors, DDM values the shares of a company by computing the present value of the future dividends a company is expected to provide to its shareholders.

Relative Valuation Methods

Unlike absolute valuation, relative methods view a share’s worth compared to other similar companies. These techniques rely on comparison ratios, often referred to as “multiples.”

  1. Price-to-Earnings (P/E) Multiple: Probably the most commonly applied multiple, it compares the price of a single share of stock to per-share earnings.
  2. Enterprise-Value-to-EBITDA (EV/EBITDA) Multiple: This method analyses a company’s total value (equity plus debt minus cash) relative to its earnings before interest, taxes, depreciation, and amortisation.
  3. Price-to-Cash-Flow (P/CF) Multiple: This measures the price of a company’s stock compared to its cash flow from operations.
  4. Price-to-Book (P/B) Multiple: Looks at the relation between a company’s stock price and its book value (equity).

Volume Weighted Average Price (VWAP)

An important tool for day traders and short-term investors, VWAP represents the average price a security has traded at throughout the day, based on both volume and price. It is a more comprehensive measure than simple averages, as it takes into account the volume of shares traded at different price levels. The formula for VWAP is the cumulative total of the product of shares traded (volume) and the trade price divided by the total shares traded for the day. For a fast and free VWAP service that you can rely on for volume weighted average price figures for both ASX and Chi-X listed shares, check out Open Drawbridge’s VWAP calculator.

VWAP serves multiple purposes:

Benchmarking: Traders often use VWAP as a trading benchmark. If a stock price is above the VWAP, it is considered to be trading at a high price for the day and vice versa.

Price Confirmation: It helps in confirming the direction of the market. Traders look for the price to cross above VWAP to confirm an uptrend and below VWAP to confirm a downtrend.

Trade Execution: Institutional investors utilise VWAP to ensure they buy or sell a stock at a price close to the average, minimising market impact.

Incorporating VWAP into share valuation is particularly useful for short-term and intraday trading strategies, offering a dynamic understanding of market trends and stock pricing.

Each method provides a unique perspective on the intrinsic value of shares, informing how to read a share price chart for a more well-rounded decision-making process.

Enhancing Your Understanding of Share Valuation Models and Methods

Understanding the foundational models and methods is only the beginning. Assessing the real value of online shares is a complex task, demanding both knowledge and experience. Here are some ways to enhance your comprehension of share valuations:

Study Financial Statements

Revenue, net income, and EPS are vital figures that can provide insights into a company’s performance. These metrics are often included in companies’ financial statements, therefore, knowing how to decipher them can be instrumental in understanding and predicting future share performance.

Track Economic Indicators

Stock market trends tend to correlate with the overall economic landscape. By keeping an eye on key indicators like GDP, inflation rates, interest rates, and unemployment rates, you can gain a broader understanding of the economy. This macro view can potentially inform decisions about which sectors or industries will fare better and therefore which shares to invest in.

Continuously Educate Yourself

Investment knowledge is a continuously evolving space. As such, always seek out opportunities to extend your knowledge and understanding of topics around investing, such as understanding different markets and exploring new valuation models.

Engage with Fellow Investors and Financial Advisors

Discussion platforms and investor groups can serve as great spots for exchanging insights and learning about investment strategies. Additionally, financial advisors can provide tailored advice on investment decisions based on your current financial situation.

Remember that while methods and models can provide insights into the valuation of a share, they are not accurate predictors of future performance. It’s essential to consider multiple factors and be patient, consistent, and informed in your investment journey.