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How to Relatively Value a Stock

By Edited Nov 13, 2013 0 0

Relative valuation is a process that most investors go through when analyzing a potential opportunity. If you want to value a stock, you can approach it relatively or absolutely. Absolute valuation is an attempt to give an exact (or range) of the price per share that a company is worth, whereas relative valuation only seeks to show under- or overvaluation of a company with respect to its competitors.

Things You Will Need

Yahoo Finance or Google Finance
SEC Filings (if you're daring!)

Step 1

Learn a few basic definitions:
Price/Earnings (P/E): the price of a stock divided by the total net income of the company for that period
Price/Book (P/B): the price of a stock divided by the total net assets of the company (net assets = assets minus liabilities)
Earnings Per Share (EPS): The net income of a company divided by the total number of shares outstanding
Market cap: the price per share of a stock times the number of shares outstanding (currently on the market)


Step 2

Next, to conduct the relative valuation using your favorite finance site, check out Yahoo Finance or Google Finance. On Google Finance specifically, when you enter the ticker symbol, it pulls up an interactive chart for the stock, but below that, you'll notice a table of comparable companies. This is where we want to focus.

Step 3

Google Finance will automatically show related companies to your company of choice. For example, if you enter JPMorgan (ticker: JPM), Google will show the statistics for Goldman Sachs (GS), Bank of America (BAC) and Morgan Stanley (MS), among others. Instantly, at a glance, you will be able to see all the important ratios (including those mentioned above) of your company and its competitors. (Hint: you can also select to "add or remove columns" to display more. There are quite a bit of options available!)

In theory, a company is attractive if it trades cheaper relative to its competitors. However, just because JPM has a lower price-to-earnings ratio of one of its competitors, does not mean that it is a good buy. There could be tens of reasons why the stock price is depressed, so as always, further research is recommended. Relative valuation is most useful as an idea generator, because if through further research you find that your company is in fact stronger than its competitors, but trading cheaper according to some metric, then it very well may be a good choice for an investment. Searching the SEC filings is the quickest way to find financial documents for any company, since all public companies are required to file quarterly at least.

Tips & Warnings

As mentioned above, always conduct further research beyond relative valuation. It should never be an end-all be-all strategy for finding stocks to buy.

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