Valuation
Wall Street investors and stock analysts scrutinize a company's financial statements and stock performance carefully in order to arrive at what they believe to be a realistic estimate of that company's value. Since a share of stock denotes ownership of a part of the company, analysts are interested in knowing whether the market price of that share is a good deal relative to the underlying value of the piece of the company the share represents.
Wall Street uses various means of valuation, that is, of assessing a company's financial performance in relation to its stock price.
- Earnings per share (EPS): EPS equals net income divided by the number of shares outstanding. This is one of the most commonly watched indicators of a company's financial performance. If it falls, it will likely take the stock's price down with it.
- Price-to-earnings ratio (PE): The PE ratio is the current price of a share of stock divided by the previous 12 months' earnings per share. It is a common measure of how cheap or expensive a stock is, relative to earnings.
- Price-to-book ratio: This ratio is the current market price of a share of stock divided by a stock's book value per share. (To calculate the book value, subtract the preferred stock total from total equities, and then divide the result by the number of shares outstanding.)
- Growth indicators: Growth measures can tell a great deal about financial health. A company's growth allows it to provide increasing returns to its shareholders, and to provide opportunities for new and existing employees. The number of years over which you should measure growth will depend on the business cycle of the industry the company is in. A one-year growth figure for an oil company—an industry that typically has long business cycles—probably doesn't tell you very much. But a strong one-year growth figure for an Internet company would be significant. Common measures of growth include sales growth, profitability growth, and growth in earnings per share.
