Share Price Valuations
How to value shares can he an extremely difficult area to navigate if you are new to investing.
There are always unexpected events the markets will not know about or will expect during any financial year like the Covid-19 Pandemic, war in Ukraine, raging inflation and now progressive interest rate rises.
One of the most common misconceptions is that things continue because they have done in the past, however one of the most common quotations you will regularly read in many investment articles is:
“Past Performance is not a guide to future returns”.
When researching any potential investment this piece of information is a key point to remember as businesses are constantly evolving and changing over time. A business you invested in 10-20 years ago may be heading in a completely different direction today.
Take 3M (Minnesota Mining & Manufacturing company) for instance. Today there is not one part of the business that is mining as it did when it started out 100+ years ago. 3M is more about innovation and manufacturing.
Look deeper into Cisco and its not just about manufacturing telephones and networking hardware, today Cisco is evolving with the internet and more specifically Cloud Computing and the (IoT) Internet of Things.
One of the most famous expressions Mr Warren Buffett is known for is:
“I never invest in anything that I don’t understand”.
Therefore it is essential that we research and recognise what makes certain companies tick before you put money towards advancing their interest.
In other words: Buy a stock the way you would buy a house. Understand and like it such that you’d be content to own it in the absence of any market.”
Before we start with the metrics the key to a successful investment is understanding the business by knowing what the company is all about, whether it provides a service or products or a mixture of both.
Conducting research reading news articles and updates on the relevant company website, then cross researching using external sources or investor websites like CNBC, BNN Bloomberg, Hargreaves Lansdown and Investing.com will help DIY investors better understand an individual business.
Another popular line you will read in investment articles is:
“When investing in individual companies it comes at a much higher risk than investing in a fund”
Investing in individual companies comes at a much higher risk than investing in either a managed, index linked or tracker fund as the risk is spread across many business all bundled into one fund.
Therefore it is paramount we understand such factors that will affect the business like competitors, delays, issues with new product development and manufacturing, legislation etc.
There may be a myriad of factors affecting a businesses performance so keeping an active eye on your investments is vital to successful investing.
But please remember “do not invest in a company that you simple do not understand” even if it is fashionable and appears everyone is jumping on the band wagon.
Company’s financials
Before we look at any of the popular metrics I always look over every company’s published financials.
Looking specifically into:
1, Revenue – is this moving in the right direction
2, Profitability – is the business making money
3, Debt – is the business over burdened with debt
4, Interest on debt – can the business support interest payments especially with higher rates
5, Cash in the bank – does the business have the finances to operate normally
6, Bottom line – EBITDA
7, Dividend – is the current dividend sustainable, dividend coverage, historical dividend payments & increases
Providing the company’s financials stack up then we can move to some of the quick metrics investors use below.
These metrics help provide a brief snapshot into a businesses performance:
Price to Earnings ratio – This is one of the most popular ratios used by investors which essentially is the price an investor is willing to pay for the earnings. The higher the number the more valued the market perceives the business in its ability to deliver profits – (In essence a safer investment or there are high hopes for it to deliver). It is best though to look at the company’s historical average in PE verses the current PE to help gain a better understanding of the current share price. The lower the number compared to its peers could mean two things:
A, it is currently better value than its rivals or
B: there is a concern with investors or maybe no-one is buying hence why its low, so further investigating may be required.
Always compare industry peers to compare the average PE for that sector, again this could provide a better understanding of that sector.
Forward Price to Earnings ratio – It should be Forecast price to Earnings ratio because it is based on the company own estimates or analysts forecast of future earnings per share. This is another metric to use as would be investors will be looking for a stable or steadily growing number. Any severe drop in this number will require further investigation as it could be that there are challenges or threats ahead indicating less profit. Inflation could be an issue or loss of market share like in the tobacco industry where it is a declining market.
PEG Ratio – Price to earnings & growth – Once again this metric is based on future assumptions in earnings, so caution when considering this figures is urged. Simply divide the PE by the companies estimated annual growth rate. The lower the number generally means a more attractive stock. Investors will usually find PEG ratios on individual company websites or investor factsheets.
Any future assumptions on projected earnings need to be considered by investors. If it is realistic then there is no reason the business would not deliver but this is down to an individuals own assumptions of the individual businesses operating within that sector. One point to investigate is if the assumptions are higher than usual. If this is the case there could be a need to dive deeper into news articles or annual reports. The business may have new product launches in the future or newly signed agreements, which in both cases should increase both revenues and profits.
Charts and graphs can provide a very quick visual measure of a company’s performance however this should never be used alone.
Personally, I only look at graphs whilst comparing events over a minimum time frame of 5-10 years before setting a reasonable purchase price. I also consider other metrics like: PE, turnover, profits, dividends, geopolitically events, inflation, recessions.
I look at graphs for a few things when considering a possible investment:
1, time or a timeline of the businesses share price
2, events vs. share prices
3, price vs. turnover/profits
By quickly digging a little deeper into a businesses financials can help us see if the current share price is worth what it is, in the current market. Look into all companies around the 2007/08 financial crisis and you will see share prices fall as investors were fleeing the stock markets for other safe havens like gold & property.
The recent pandemic is also another great time to look at historical charts to help us all quickly look at share prices verse market volatility.
Take a closer look at the graph and events from 2007 through to 2009, then again 2014-15 and 2020 the pandemic.
All these events that are outside the companies control. At a point in 2020 we can see the price bottom out to around £9.40 ish per share.
It can be difficult seeing your investments crash in value however staying the course and sticking to your original investment thesis and beliefs in any particular company can pay off over the longer term of the stock market.
I purchased a further 200 shares around £13 when the shares started to recover in 2020, these shares are now trading between £20 to as much as £24.70 recently.
With tight supplies and further geopolitical forces at play here these could reach the high twenties in the near term.
Getting back to the terms of where I would value the shares now, considering all the above metrics realistically I would be setting a target price between £17.50 – £20 with a long hold. Exiting around £27.50 – £30.00 per share.
Website Disclaimer:
Please remember that all investments can rise and fall in value, therefore you may get back less then you originally invested.
This website or webpage is not a suggestion to purchase or invest in any stocks / equities and is presented purely for research analysis.
Should you be unsure of any investment whether it be purchasing shares or equities directly, funds or investment trackers, you should seek independent financial advice from a qualified financial advisor.