When it comes to stocks, share price isn’t everything. In fact, it isn’t much at all. The real question is, “What is the share price compared to what that tiny piece of the company is actually worth — or will be worth?” Unfortunately for the average retail investor, there are a raft of different formulas to measure that, and different yardsticks for each.
In this segment from the Motley Fool Money podcast, host Chris Hill and Fool senior analysts Aaron Bush, Ron Gross, and Jason Moser address the question of a listener who wants to know their favorite ways to value companies — and at least one method will likely be unfamiliar to you.
A full transcript follows the video.
This video was recorded on Jan. 25, 2019.
Chris Hill: Question from Nick Burgess in Atlanta, Georgia. He writes, “Hey, guys. Love the show and everything it has helped me learn in my young investing journey so far. As I’m only 26 years old, I’m looking for companies that I can stick with for the long haul. I know I need to look for companies within my circle of competence with great management teams, but I always hear about looking for companies that are undervalued. With that in mind, what is your favorite way to value a company? Again, thanks for all that you do.” Thanks for listening, Nick! Thanks for the question! Ron, you’re up first.
Ron Gross: I could talk about this for hours.
Jason Moser: He literally could.
Hill: We don’t have that kind of time.
Gross: I’m going to give you one that’s off the beaten path and is perhaps easier, and that’s called earnings power value. It assumes a company has no growth and you value it assuming it’s stable. Then, you can compare the no-growth value that you get to the current price to determine what you’re actually paying for that growth.
Hill: That sounds like it involves math.
Gross: A little bit of math, but it’s easy.
Hill: Jason, what about you?
Moser: I preface this by saying that valuation is more art than science. It’s an option, really, and everybody’s is probably a little bit different. I know a lot of people like to look at cash flow. I do like to look at that. But I also think that generally speaking, most people are out there looking at actual earnings per share. I do like to fiddle with these income statements and stretch out earnings per share five years down the road, get an idea of what the company’s going to be earning, and look at it from a multiples perspective.
Aaron Bush: I think it’s important to learn how these different frameworks work. Discounted cash flow, earnings, power value. I may be a little bit different in the sense that the companies I’m looking for are the ones that break all of these models. I’m looking for the companies that can grow faster and longer than what most people would plug into those models. There are qualitative reasons why that happens. Optionality, great products, great leadership. You could go a million ways with it.
Moser: I think that’s really the point. Something we’ve learned here with our years as analysts is, the idea in analyzing stocks and valuing these stocks is having as many tools in your toolbox as you can. There’s no one right way to value a company. There are better ways for certain markets and whatnot. Learning all of those different ways over the course of time is the most valuable way to go about it.