Purpose of Valuation

• Without conducting proper stock valuation, investors may not know whether a stock traded in the market is overvalued or undervalued. Investors need the information to make investment decisions. If a stock valuation reveals that a stock is overvalued by the market, investors may not want to buy the stock, but may consider selling it. If the stock valuation reveals a stock is undervalued by the market, investors may want to buy the stock or continue to hold it if it's already owned.
  
  

Price Multiple Analysis

• Price multiple analysis directly compares a stock's price with a representative intrinsic value of the stock, such as company earnings or book value. The most common price multiples are price-to-earnings ratio and price-to-book ratio. To determine whether a stock is fairly valued, investors further compare a stock's various price multiples with those of similar stocks or averages for their industry as whole. If a stock's multiple is higher or lower than most other stocks' multiple or higher or lower than the industry's average, investors may judge that the stock is overvalued or undervalued as a result.
  
  

Discounted Valuation Method

• The discounted valuation method is based on the broad concept that the value of any investment is the present value of the discounted future cash flows an investment expects to receive. In stock investments, dividends distributed over time by companies may effectively represent the stream of future cash flows. To solve for the present value, or the presumed stock value, investors must estimate future dividends and have them discounted back to a present value at the rate of their required return. If the derived value is higher or lower than a stock's market price, the stock may be undervalued or overvalued by the market.
  
  

Valuation Method Comparison

• Both stock valuation methods can be useful in different situations. Price multiple analysis can provide quick investment evaluations that don't require definitive valuation results. Moreover, for average investors or non-dividend stocks, price multiple analysis becomes an easy alternative. However, for stocks that do pay dividends, the discounted valuation method often renders more accurate and reliable valuation data for making investment decisions.