Making Stock Valuation Simple
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Simple and easy description of how to understand and apply stock valuation.
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Making Stock Valuation Simple
- 1. Keeping Valuation Analysis Simple © Investors’ Mosaic, Inc.
- 2. Section 1: The S&P 500 © Investors’ Mosaic, Inc.
- 3. The S&P 500 Valuation Range (Forward Price / Earnings) 20x 15x 10x Bad Times Normal Times Good Times Analysis: Over the decades, the S&P 500 has generally fluctuated between 10x and 20x forward price/earnings. There have been years well above and well below these levels, but they were short-lived aberrations. In most scenarios, these are good guideposts to use when analyzing the market’s valuation. © Investors’ Mosaic, Inc.
- 4. Section 2: Individual Stocks © Investors’ Mosaic, Inc.
- 5. Individual Stocks Trade in a Range: Learn the Cycle Business fundamentals are very strong; revenue and earnings growth accelerating. Sector in favor. Peak Business fundamentals 20x Know where the stock is are stable. Nothing within this cycle to better out of the ordinary. assess if valuation and business fundamentals are aligned. Average 15x Trough 10x Business fundamentals are weak, slowing or declining earnings growth. Sector out of favor. © Investors’ Mosaic, Inc.
- 6. Reasonable Forward P/E Based on Earnings Growth Rates Analysis: You should be willing to pay more for faster-growing companies. Generally, paying 1.0x the company’s EPS growth rate is acceptable. Some experts think that paying up to 2.0x EPS growth is o.k. 35x Note: Paying more than 50x EPS is extreme in any scenario and will ultimately burn you. P/E 20x 15x 10x 8x 5x Declining EPS ~5% ~10% ~15% ~20% 30%+ Growth Growth Growth Growth Growth Earnings Growth Rate © Investors’ Mosaic, Inc.
- 7. Or You Can Think About Your Stock Relative to the Market If your company is If your company is below-average quality above-average quality 18x 15x 15x +3x -3x 12x The S&P 500 in Relative P/E The S&P 500 in Relative P/E Normal Times Normal Times Analysis: Most companies are average, but a good management team, a unique value proposition (product), and attractive industry may be reasons for an above-average valuation. The reverse is true for below-average. © Investors’ Mosaic, Inc.
- 8. Section 3: Establishing a Price Target © Investors’ Mosaic, Inc.
- 9. Regardless, Always Establish Price Targets So You Can be Disciplined When to Buy or Sell Analysis: You can $18.00 further refine the Target Price in scenario analysis by Upside Case establishing a different EPS expectations for all $15.00 three cases (in addition to varying multiples). Target Price in This adds complexity to Base Case the analysis, but is also more realistic since your $12.00 downside scenario is associated with a Target Price in negative sentiment in the Downside Case market, which can be driven by a poor macro environment. EPS Multiple Price Downside Case $1.00 12x $12.00 Base Case $1.00 15x $15.00 Upside Case $1.00 18x $18.00 © Investors’ Mosaic, Inc.