How to Determine the Value of a Stock
- 1). Determine company earnings. This is also referred to as EBIT (earnings before interest and taxes), net income, or EPS (earnings per share), which is calculated by dividing net income by the number of shares outstanding. This information can be found on the company's Income Statement in the 10K or 10Q.
- 2). Calculate the price to sales ratio (PSR). This ratio helps investors to determine the value of a stock based on topline growth factors. The calculation is "market capitalization"/"last twelve months of revenue". Market capitalization is the "current price of the stock" multiplied by "the number of shares outstanding".
- 3). Calculate EBIT. This is "earnings before interest and taxes," which is calculated by taking sales minus cost of goods sold minus operating expenses. EBIT is looked at as a measure of free cash flows available to pay out to shareholders or creditors. It is considered a measure of free cash flows.
- 4). Find multiples to compare EBIT with. A multiple is a number you can use to compare stock. Research recent mergers and acquisitions in your industry. These deals provide a gauge for what similar companies are valued. Compare the price paid for the company by the company's free cash flows (price to cash flow) and then compare that to your company's prices to earnings (PE). Note: It is common for a premium to attach to companies being sold in M&A deals for advisory. For this reason, these deals will probably have higher multiples.
- 5). Walk through an example. According to the news, XYZ company was bought for $1 million. EBIT for the company is $100k, which means the company is trading at 10 times free cash flow in the market. This is your trading multiple.
- 6). Multiply this multiple (10) by free cash flow (EBIT) for your company. Let's say the EBIT (sales - cost of goods sold - operating expenses) is $50k for your company. $50k times 10 is $500,000, which is a high end estimate for how much your company is worth in the marketplace.
- 7). Divide this number by the total number of shares outstanding for the market value of one share of stock. Find the number of shares outstanding on the balance sheet or in the notes to the financial statements.
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