Effective Stock Valuation Model

We're going to review in detail two practical stock valuation models that we have used with great success.

What Is A Valuation Model?

Quite simply, it is a method or tool to carry out the valuation of a stock. The objective is to come up with an estimate of how much a share of stock is actually worth given the fundamentals of the company behind the stock.

The most common way of gauging the price of a stock is to use rule of thumb PE values. This method is okay if all you're looking for is a quick comparison among similar companies. But if you want to get a better estimate, you have to use a more rigorous analysis.

More rigorous does not mean complicated. Let's take a look at the two valuation models we've used with great success....

1. Discounted Cash Flow (DCF):
   

   The main idea behind a DCF model is relatively simple. If you add up all the future cash flows you estimate a company will encounter, discount it to today's value, you get a fairly good idea of how much a company is worth.

2. Earnings Projection using the EPS-PE relationship:
   

   This method projects out the Earnings per Share (EPS) several years into the future, estimates a Price/Earnings (PE) ratio and arrives at a future stock price. That number is then translated to today's price.....

To wrap up, we discussed what exactly a valuation model is and looked at two key models we like to use — the DCF model and the Earning Projection model.

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