Valuation

A Valuation is done to determine a theoretical price for the Shares based on forward projections. There are two broad Valuation methodologies, Ratio Analysis and an Intrinsic Valuation.

The overall objective in determining a stock’s Valuation is to estimate a theoretical price value, commonly known as a Price Target. The Valuation has nothing to do with the currently traded Share Price. The relevance being, is it above or below the current Price and by how much. To determine a Price Target for a Stock, requires researching, analysis and an estimation of a Company’s future earnings. Therefore, a forward projection requires an understanding of the key dynamics in the three Financial Statements. The growth potential of the P&L, how the Company is financed, key being leverage and liquidity and is the cash position positive. Starting at the top line in the P&L, Sales , Product Pricing , then Volume, demand and competition, then Operating Expenses, then Interest Expenses and Taxes, leading to Net Earnings.

The Valuation of a Stock and ultimately determining a Target Price can be done by either a Relative Valuation or an Intrinsic Valuation. The Relative Valuation is done via the key Valuation ratios, Price / Sales per Share, PE Ratio, Dividend Yield and Price / CF per Share. The multiples and yields of the current Ratios are then compared to the historical Mean, for that Ratio, as valuation multiples tend to be Mean reversing, unless justified. For example, due to continued growth via product innovation Apple (APPL) enjoyed a multiple expansion over the past two decades. Then the Multiples are compared on a relative basis to the forward Mean Sector Valuations and the main Index Valuations projected for the next two years. Also taking into consideration potential growth rates. A higher PE Ratio could be justified if the potential growth rate is higher.