# Essential Stock Valuation Models for Wealthy Entrepreneurs

The Idea Trader is dedicated to spreading interesting ideas and current news to readers and interested parties. This blog contains opinions and insights for ideas and investment opportunities and is not intended as advice for investing.

*September 22, 2021*

As an entrepreneur, you're undoubtedly well aware of how tough it may be to turn a profit. Once you've begun making money, you'll need to safeguard and increase your assets in the event that the market declines.

This implies that you must invest carefully.

Investing in the stock market is one of the greatest methods to increase the money you've earned through your company. Over the past 40 years, the average return on the Australian stock market has been 11.49 percent.

Using the proper stock valuation methods may help you develop faster.

What are the advantages of using these models? You'll be able to discover stocks that are undervalued.

The most popular stock valuation techniques are divided into the following groups. If you learn and implement them, you will become a better stock investor.

## Methods based on equity

These valuation methods use the balance sheet to evaluate the company's worth. As a result, this is a static valuation, in which the company's condition is only considered at a particular and predetermined point in time.

Discounted cash flow methods are a kind of discounted cash flow method.

The net present value of a company's future cash flows is used by investors to determine its worth. The cash flow statement calculates the company's cash flow by adding depreciation and provisions to the net profit and deducting working capital needs (also known as "operating cash requirements") and fixed asset investment. As a result, this approach concentrates on the company's ability to create resources.

## Stock market ratios-based methods

The method evaluates a business by comparing it to other publicly traded companies in the same industry (sector, size, etc.) using the same ratios. This is a fantastic method to figure out how much a company is worth based on its expected profits in the future. The PER (Price per share/Earnings per share) is the most frequently used ratio, although there are others as well:

- Dividend yield is calculated as the sum of the dividend per share and the price per share.
- Price/Book Value: This ratio compares the market value of a business to its book value, indicating the percentage in which the market values the company's book value.
- ROE (Return on Equity, or financial profitability) is a metric that assesses a company's ability to produce profits from its owners' equity (capital stock plus reserves).
- Profit / Shareholders' Equity Equals Return on Equity.
- Debt/EBITDA: This ratio represents the company's ability to take on new debt and restructure existing debt. As a result, it's a metric for determining the relative degree of financial leverage (debt contracted).
- EBITDA stands for earnings before interest, taxes, and depreciation, or earnings before interest, taxes, and depreciation. This ratio indicates how long it will take to pay off all of the debt using operational income.

## Price-to-earnings ratio (P/E)

The most frequent ratio employed in stock market research is the price-earnings ratio, which is defined as the quotient between the price per share and the earnings per share.

For example, a firm with 100 million shares has a share price of 30 euros per share and a profit (net of tax) of 300 million euros in the previous financial year.

30/(300.000.000/100.000.000) = 30/3 = 10 will be the PER.

Different information is provided by the PER. It represents the stock market's multiple of earnings per share, or the number of times investors pay a company's yearly profit.

It may also be interpreted as the amount of years it will take an investor to recoup his investment (assuming that profits are maintained and fully distributed).

The inverse of the P/E ratio (1/PER) calculates the expected return on an investment in a stock, assuming that the company's profits do not change in the future years and that the full profit is paid as a dividend.

The P/E ratio is typically computed using the previous year's profits as well as the anticipated earnings for the current year. As a result, depending on whether their P/E is greater or lower than that of other businesses, we typically speak about more costly or less expensive companies.

For example, at the end of year N, the following information is available for a company: Share price: $80/share; number of shares outstanding: 1,000; unit book value of shares: 140; shareholders' equity: $140,000; debt: $50,000; EBITDA: $70,000; annual result: $30,000; dividends: $10,000; share price: $80/share; number of shares outstanding: 1,000; unit book value of shares: 140; shareholders' equity: $140,000. The most frequent ratios will be calculated using the aforementioned techniques using stock market ratios from the data given above.

PER = 80/30 = 2.67 (price/earnings per share).

[dividend per share/share price] x 100 = [10/80] x 100 = 12.5 percent dividend yield80/140 = 0.57 price/book value (57 percent ).

Earnings/equity = 30,000/140,000 = 0.21 Return on Equity (21 percent ).

50,000/70,000 Equals 0.71 in terms of debt/EBITDA (71 percent ).

In terms of this ratio's application, a prospective investor will be interested in businesses whose P/E ratio is low in comparison to other similar companies or is comparable owing to their features. In addition, the P/E ratio tells us how many times the profits per share are paid out.

A P/E of 10 indicates that we are paying 10 times the net earnings per share for the stock. If the profits number remains constant, it will take ten years to recoup the cost of the stock.

Purchasing a stock with a high P/E, on the other hand, does not always imply that it is a poor investment, since if it is a firm with excellent business prospects, its profit will inevitably rise and its P/E will fall over time.

In this regard, it is critical to consider not just the P/E at any particular time, but also its development over time.

*Thanks to Matt James at Business 2 Community whose reporting provided the original basis for this story.*