What Is A Good P/S Ratio For A Growth Stock Valuing Valuations

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Valuing Valuations

There are only two types of valuations available for stocks. One is an educated guess as to what the stock could, should or would be worth after looking at all of the different valuation methods and techniques that could possibly exist. The other type is found by typing the stocks ticker symbol into a financial website, seeing what the last quoted price was and then knowing what it is actually valued at in real-time. Yes the second type is a lot simpler than the first, but do not get too excited just yet. Neither type could exist without the other one, and unfortunately if you want to make any money buying and selling stocks, you will have to learn how to use both.

The actual valuation of a stock in real-time is calculated by simple supply and demand. It is found by looking at the last actual sale of stock that has occurred based on a simple auction method. Multiplying the share price by the number of shares the company has outstanding will give you the total value, or market capitalization of the company. Since this is completely straight forward and simple, we will focus on the other type of stock valuation for this article, the educated guess type. Just keep in mind that many of the methods for calculating an educated guess are derived from the actual real-time supply and demand price, so it is important to not only know where the stock is now, but where it has been in the past.

What is the point of forming an educated guess as to what you think the stock should, could or would be worth? Whether you call it fair value, intrinsic value, fundamental value or something else, the point is that you are looking for a number that is separate from the current price. Once you determine this number, you can compare it to the current price and decide whether the stock is undervalued, overvalued, or valued just right. Analysis should not end here, however, you also need to determine if the stock is under or overvalued for a reason, or for no reason at all. One way to gain tremendous insight into this dilemma is to look at historical valuations of the stock, not just current ones. You will also want to look at current and historical valuations of closely related stocks, stocks in the same sector, stocks of similar size, and even all stocks in general.

If you are reading this article, there’s a pretty good chance that you’ve heard of P/E or the price to earnings ratio. This is without a doubt the most popular valuation measure. EPS or earnings per share is the ultimate bottom line with respect to how well a company is doing. We can look at the current P/E, which is the current price divided by the trailing twelve month earnings, and we can say the lower the P/E is, the cheaper the stock is. We can also look at forward P/E by taking the current price, and dividing it by forcasted earnings for the next year or two years. We can also take the P/E and divide it by forecasted earnings percentage growth, which is known as the PEG ratio. Typically, a PEG of 1 is considered fair value.

If you are interested in lower priced stocks, as we are, you probably know that earnings are not quite as abundant as the stock price gets lower. This means that we have to look at more creative ways to value the stocks that we are interested in. This is where we believe an advantage exists for small and micro cap stock traders who become adept at valuing shares. Without as many cut and dry valuation ratios to go by, stock prices in this arena tend to become more and more inefficient, therefore, issues can become grossly under or overvalued.

There are tons of ratios and measures to look at, all of which are derived from either the income statement, balance sheet or cash flow statements. Many of these numbers are divided by the stock price or the number of shares outstanding or both to give us a per share figure that is easier to contemplate. You’ll be able to find a ton of ratios to ponder just by looking around at financial websites a little bit, and a lot of them are self-explanatory. We’ll take a look at a couple you may not have thought about, but keep in mind that the more ratios you look at, the better. Even if you feel confused by the end of your exhaustive research, we guarantee that you will be able to come up with a much more efficient guess than those who only look at P/E’s.

Price to Sales or P/S compares the current stock price to trailing twelve month top line revenues. This number will vary a lot more than P/E will among different stocks. Keep in mind that the sales part of the equation is calculated on a per share basis, therefore, the less shares there are outstanding, and the more revenues the company has, the better, or lower, the number will be.

Enterprise value is a better way to value the company as a whole than just looking at the market cap. When a company is taken over, the buyer has to take on the company’s debts, but gets to pocket the cash, and enterprise value is a good approximation of what a suitor would have to pay. EV is calculated by taking the market cap and adding all of the short and long term debt, as well as accounts payable. Then you subtract the cash and cash equivalents, as well as accounts receivable.

EBITDA or earnings before interest, taxes, depreciation and amortization is a pretty good earnings normalizer. Keep in mind that most financial firms calculate EPS, P/E and PEG with non-GAAP, or pro forma numbers. These are earnings before large, one time items and can be less normalized than EBITDA. If you really want to get fancy, a great valuation measure to look at is Enterprise Value to EBITDA and be sure to compare it with other companies.

Don’t forget to look at all of the balance sheet ratios, like book value, price to book value, price to cash and so on. This is a good way to find stocks that may be undervalued if you have a longer time frame to work with. Has the stock had low balance sheet valuations for a long time? If so, it may be a very safe and boring issue. Have they suddenly become low? Something on the earnings or revenue front may be the culprit. Always be aware that ratios that are just too low are almost always a bad sign. Once again, the take away here should be that the more dimensions of stock valuations you can see, hear, smell, taste and touch, the more likely you are to make a good decision.

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