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Stock Valuation Methods

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Stock Valuation Methods

Understanding Stock Valuation Methods

When a stock market analyst makes a stock buy or sell recommendation, they use variety of stock valuation methods to assess whether a stock is cheap or expensive.  While stock market professionals often use proprietary and complicated stock valuation methods, there are many common stock valuation methods that stock market traders and investors of all experience levels can utilize to improve their stock picking performance to ultimately help them achieve their stock trading and investing goals.

Common Stock Valuation Methods

The stock valuation methods outlined below have been tested and proven over many decades of stock market trading.  Instead of relying on just one stock valuation method, it is recommended to use a number of these methods to gain a clearer picture of whether a stock is undervalued or overvalued.

Price-to-Earnings ratio (P/E ratio) is one of the most widely used and discussed stock valuation methods.  Determining a stock’s The P/E ratio is rather simple:  divide the stock price by the earnings per share that a company reported over the past twelve months.  The lower the P/E ratio the more undervalued the stock, at least in theory.  In practice, it is important to look at other factors in conjunction with the P/E ratio, when assessing the valuation of a stock.

The PEG ratio (PEG = Price / Earnings / Annual Earnings Per Share Growth Rate) is a stock valuation method that is very useful to look at in conjunction with the P/E ratio.  While a P/E ratio gives you a picture of what a stock’s value is based on past earnings, a PEG ratio is a method of looking at potential future stock valuation.  The lower the PEG ratio, the more undervalued the stock, as a low PEG ratio indicates a sufficient future earnings growth rate to support the growth of a stock’s value and theoretically its price.  The biggest pitfall to watch out for when using the PEG ratio to value a stock is the potential that the estimated the annual earnings growth per share rate is too high and earnings will not materialize to support the stock’s future price.

Bullish to Bearish Sentiment ratio is a useful stock valuation method that is a way to gauge whether a stock or the overall stock market is undervalued or overvalued.  While people want to buy stocks or invest in the stock market when other stock market participants are bullish and expect stocks to go higher, extreme bullish sentiment is often a signal of a near term top for a stock or the overall stock market.  The opposite is true of extreme bearish sentiment, as near term stock and stock market bottoms are often reached when bearish sentiment is extremely high.

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