The stock valuation method

The Real Stock Value contrary to other price forecasting software is based on value investing and not on technical investing.

Legendary investors like Warren Buffett, Jim Rogers, Mark Faber, Benjamin Graham, Robert J. Shiller, and Philip A. Fisher are using this approach.

Jim Rogers famously said: "I haven't met a rich technician."

Warren Buffett: “Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” And a few more: “The best thing that happens to us is when a great company gets into temporary trouble… We want to buy them when they’re on the operating table.”

 “Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”

But how to value a company or an entire index?

There are a lot of methods, but three of them are universally used by successful value investors.

Price-Earnings ratio or P/E. This is the most heavily used value based investment metric and rightly so. It means how much we pay for a given income stream. Most value indicators are an advanced form of the P/E ratio, for example the Shiller’s cyclically adjusted price-to-earnings ratio (CAPE).

Price-Book Value ratio. This number shows us how much we are paying for the given companies assets, like real estate, plant, equipment, intellectual property, and brand. It also gives us a hint how much money would it take to recreate that business.

Price-Sales ratio is another number to look at. A company’s earnings, profits, or even book value easily can be manipulated, however it is really hard to manipulate sales numbers, and that is why Marc Faber prefers this metric when evaluating markets.

For every industry there is a profit margin that you can expect from a well-run company. Based on the sales, possible profits can be estimated. If the profit margin is very high, probably it will not stay there for long, because competition will appear, and push down prices.

The last parameter used is dividend. In theory, the stock or company is the asset and the dividend is the income stream. In perfect tax conditions, companies should return the profits to shareholders in form of dividends, and withhold cash only for investments to grow the company. Taxation makes this more difficult. I will not discuss this topic here, however a company with healthy dividends shows, that the company is actual profitable, not just on paper, it has shareholders interest in mind, and willing to distribute profits to shareholders.

In addition to these parameters strictly related to the given asset, more advanced users may want to include the effects of growth, expected returns in other asset classes, and also the effects of inflation or treasury yields.