The price may be the first consideration while purchasing equities. However, a stock’s worth and price are not the same thing. You may determine whether a stock’s present price is affordable or overpriced by taking a look at its value. This can assist in determining if it is worthwhile for you to invest or not.
It’s easy to determine a stock’s price. But determining its worth is a little trickier. But even for the typical investor, it’s not impossible.
The EPS, P/E, and PEG ratios are three of the most crucial metrics for determining a stock’s value. Find out more about these and how they might assist you in deciding where to place your money.
Why Can’t You Always Tell a Stock’s Value by Its Price?
It can be tempting to purchase as many cheap stocks as you can in the hopes that their value would increase over time. The cheapest stock, however, might not offer the best genuine value.
At first glance, a $5 stock could appear like a good deal. But you might not get the best return on your investment if you’re working with a shaky business. On the other hand, it may be more difficult to decide whether to buy in a $150 stock because it is more expensive. However, if it offers dividends and has a track record of steady development, it can be a safer investment.
The value of a stock is influenced by numerous factors than just the company’s age. You can accurately determine a stock’s value beyond share price by looking at three different pieces of data. These are the price/earnings-to-growth (PEG), price/earnings-to-earnings (P/E) and earnings per share (EPS) ratios.
How Can You Determine the Value of a Stock Using EPS?
Many novice investors believe that a stock’s price, whether it be “cheap” or “expensive,” is equivalent to its value. However, seeing these as one and the same can result in foolish investing decisions.
Let’s examine the stocks of two fictitious companies as an example.
Jones Organic’s shares sell for $2,000 whereas Smith Organic’s share price is $10. Which one costs less? At first look, Smith’s stocks would appear to be the superior deal because they are far less expensive. But perhaps that isn’t the case. This is due to a concept known as “profits per share” (EPS). Earnings per share, or “EPS,” calculates a stock’s value based on the total number of shares outstanding and the company’s net profit.
Say Jones Organic has 1,000 outstanding shares whereas Smith’s Organic has a million shares. If both businesses generate a million dollars in revenue annually, Jones Organic offers more value. That is as a result of its significantly higher profit per share.
Smith Organic: $1 million in profit divided by 1 million shares equals $1 per share.
Jones Organic: $1,000 profit divided by 1,000 shares is $1,000,000 profit.
1,000,000 shares of Smith Organic are worth $1 in profit. However, Jones’ 1,000 shares are valued at $1,000 each, which is a far greater price. One Jones Organic share is 100 times as valuable than one Smith share, despite costing more. However, EPS shouldn’t be the only factor you consider when choosing a stock.
Understanding a Stock’s Value Using P/E
The price-to-earnings (P/E) ratio is another well-liked method of assessing stock pricing. How much investors will pay for each unit of earnings is shown by the P/E ratio. Businesses use this indicator to determine whether the stock price is greater or lower than in the past. It can also be used to contrast the stock values of several corporations.
Divide the current stock price by the current earnings per share to get the P/E ratio. Investors are prepared to pay $50 for every $1 of profitability if a stock has a P/E ratio of 50.
Here is an illustration of how to locate P/E:
Smith Organic: P/E of 10 is $10 price per share / $1 profit per share.
Jones Organic: P/E of 2 is equal to $2,000 price per share / $1,000 profit per share.
The $2,000 stock of Company Jones Organic is still far more expensive than Smith Organic’s $10 stock. However, the Jones stock is more affordable because of its lower P/E ratio.