8th letter to friends of Brunei [Stock Valuation (part 5)]

Before I sign off from stock valuation, let me highlight some points.

1. Whether it is dividend discount model or P/E method, we are trying to establish an intrinsic value of a stock.

2. This intrinsic value (of the stock) is then compared with the current price of the stock.

3. If the intrinsic value is more than the current price of the stock, then the stock is undervalued, which could lead to a "buy" decision.

4. If the intrinsic value is less than the current price of the stock, then the stock is overvalued, which could lead to a "sell" decision.

5. Financial analysts commonly refer high P/E stocks as "growth stocks", low P/E stocks as "value stocks".

6. P/E ratios are the most comonly used, but it is not a perfect ratio. For example, if the the earnings are low or negative.

7. The other less common, but equally sound, ratios are:

a. Price-Sales Ratio (PSR) = Market Value of Company / Last year's sales

(market value of company = stock price x total stock outstanding)

b. Price-Cash Flow Ratio (PCF) = Market Value of Company / Operating cash flow

c. Price-Book Ratio = Market Value of Company / Stockholders' equity

(Stockholders' equity = Total Assets - Total Liabilities)

Cheers!