What is a Stock Worth
Purchasing stocks from the Stock Market is not like purchasing items from a supermarket. For one thing, the price of a stock is likely to change from minute to minute, while the price of an item at the supermarket is only likely to change if it is on sale. In addition, it is pretty easy to determine whether or not you are getting a good price from a particular supermarket, all you have to do is compare their prices with other supermarkets in the area. But, with the prices of stocks changing moment by moment, how do you determine whether a stock price is a good value or not? The Stark Market is the only place I can think of where a $50 stock can actually be a better value than a $5 stock. But how can you know? A good start is by learning how to calculate a stock's "price to earnings" ratio.
When you purchase stock in a company, how do you know what it is worth? A company is valued on the basis of their earnings (profits), future expected earnings and growth. Determining the valuation of stocks requires knowledge of the price to earnings ratio. In order to determine if a particular stock is a good value or not you'll have to know how to calculate its P/E ratio.
EPS - Earnings per Share
The first thing you must know when valuing a stock is its "earnings per share" (EPS) value. The EPS are a portion of a company's profit allocated to one share of stock or the earnings returned on the initial investment amount. The EPS equals the amount of money a shareholder would be eligible to recoup in the event of liquidation. The higher the EPS the better it is for a stockholder.
Amazon Price: $24.99 $13.96 Buy Now
(price as of Jun 29, 2013)
The Earnings per share is calculated by dividing a company's net income (minus preferred dividends) by the average shares outstanding.
P/E - Price to Earnings
The price to earnings multiple is the real value of the stock and represents how many times more than the earnings the Market is willing to pay for the stock. Price to earnings is determined by dividing the amount a stock trades for by the amount a company earns per share (EPS).
Stock price divided by the EPS equals the P/E ratio.
The P/E multiple represents the true value of the stock, a valuation ratio of a company's current share price compared to its per-share earnings. One way to determine whether the price of a stock is a good deal or not is to compare the P/E stock multiple to that of the company's competitors.
So, if a stock price is $5 but the P/E multiple is $0.20, while the price of another stock is $50 but their P/E multiple is $7.50, the best value is the $50 stock.
Amazon Price: $22.95 $11.85 Buy Now
(price as of Jun 29, 2013)
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