Question – What is the best way to value a company’s share price that is listed on the share market?
Answer – A great question and one that puzzles investors every day of the week. Summarised below are some common methods for valuing shares:
- Valuing a company’s share price based upon their expected earnings (profits) – Investors will predict, as best they can, the future earnings (profits) of a company and these earnings will need to satisfy a pre-determined expectation. For example, if you wanted a 10% return on your investment and company ABC is currently trading at $5.00 per share, you would need to be confident that future earnings would represent 50 cents per share or more before investing in the shares of ABC company ($5.00 @ 10% = 50 cents). This calculation also assumes that the share price does not fall below $5.00.
- Valuations based on growth prospects – Often these companies may not have any positive earnings; they could in-fact be running at a loss. However, growth style investors will be seeking companies that exhibit ‘potential’ for strong profits in the future. Many growth based companies are associated with mining; this is because the mining company needs to spend its initial funds (capital) to develop a mine before it can sell the raw materials to make a profit.
- A ‘like for like’ comparison – This is where you look at similar companies in a sector that you see as being profitable (either now or in the future). For example, if you believe the banking sector could be very profitable, you could easily compare banks and buy shares of the bank that you felt was currently the most undervalued.
- Strong management – While not a distinct valuation method, many investors are prepared to pay a premium for companies that have demonstrated a history of strong management, i.e. value a company’s share price more than its direct competitors.
It is important to note two major factors with valuing shares
- No matter what the so called experts say, there is no ‘guarantee’ on getting a valuation right. This is what makes the share market so interesting
- Ultimately, the valuation of any share is the value of the current ‘bid’ price. In other words, “A company’s share price is only worth what someone is willing to pay for it.”