Month: January 2023

Evaluating a stock can be a tedious task especially when you do not know where to start. In this article, I will show you how to calculate stock price in 3 easy ways.

There are a lot of ways how to do it and you can find them on the internet. Each of them is different a can get you very different results. However, there is nothing to worry about as you have to know what exactly they evaluate.

I will show you the basics of how to calculate stock price and determine which companies you should investigate further and which ones are better not to touch.

Why Do You Want To Evaluate a Stock Price?

If you are fairly new to investing you might be thinking that there is nothing to evaluate. If you like the company and you believe that it will grow then you should invest in it.

Well, from my personal experience, I would suggest that you do some research and give more time for your initial evaluation as you might be losing money on your poorly chosen strategy.

In the old beliefs that are now disproven companies are always selling at the correct value as it should be. So, basically, you see a price that the company is worth right now and you either buy it or don‘t.

This is not entirely true as people are not acting rationally all the time especially when they are scared or too greedy. Because of that stock prices may have altogether different values according to their intrinsic value. Intrinsic value means valuing a company based on its cash flow.

How To Calculate Stock Price?

Now that you know that you should check more than the face value of the company what should you really care about?

There are 3 main things that you should check to see if the company is interesting at the moment or not. These 3 things are a competitive advantage, ratios, and technical analysis.

1.     Competetive Advantage

The first step in how to calculate stock price is checking if the company has a competitive advantage.

Competitive advantage often can be called a moat. Many investors suggest you consider it as a water-surrounding castle and protect it from intruders. This is exactly what a moat means – it protects the company from others stealing market share.

Low-cost and high-quality leader

Companies that have this kind of competitive advantage are big companies that can purchase their resources cheaply because of their buying power. The more company buys the better prices it can negotiate.

By doing this, companies can offer products cheaper and when there is a downturn in the market competitors might have to increase prices but a company with a low-cost moat can lower its gross profit and even grow going more market share. Thus creating a snowball effect.

Buying resources cheaply can also allow companies to offer higher quality products than other companies with similar prices as their expenses are lower.

The best way to find out if a company has this kind of competitive advantage is by visiting a company‘s website or comparing companies in the same industry with free online tools like finviz.

A company like Costco definitely has this competitive advantage as it has 847 stores in the world as of 2023 January and their revenue last year was 222.7 billion USD. Imagine quoting a price from a supplier for a few million items each month when competitors have a lot smaller demand. Of course, Costco gets the best price.

Known Brand

Known brand competitive advantage is achieved when a company is established in its market. In fact, it is more like when you think of a product and one particular brand comes to mind.

For example, if you think of a smartphone, who has not heard of Apple‘s iPhone? If it is a beverage drink then everybody thinks of Cola. And if it is coffee then there is probably no American who at least does not know that Starbucks exists and how they always misspell your name on the cup.

There are a lot of different reasons why a company can achieve this. Still, in most cases, it is because of very aggressive marketing to the point that Pampers brand has become a noun in people‘s minds or the company changed the market with its innovation.

Other moats

The moats mentioned above are the most common. Some include switching, network effect, toll bridge, and secret.

For more information about moats, I suggest you read my other article Investment checklist by ‘Invested‘.

2.     Ratios

When you have established that the company has a moat you have to ask how to calculate stock price. That means checking how it is doing financially compared to others. A lot of different ratios can be found online that can help you do that. I will go through the most important ones.

Price To Earning Ratio (P/E)

The best-known ratio out there is the price-to-earning ratio (P/E). You can find this ratio almost everywhere. The P/E ratio is calculated by dividing a stock price by the company‘s most recent earnings per share (EPS). EPS is calculated by dividing the company’s profits by its outstanding shares.

To put it simply, the P/E ratio shows how much investors are willing to pay for the company’s earnings. In general, it is said that it is good if a company has a ratio below 25. However, it highly depends on the industry average.

I suggest you read more about 11 Stock Market Sectors.

Price To Sales Ratio (P/S)

Price to sales ratio (P/S) is a very good metric that shows how well a company is growing when it does not have huge profits yet. The P/S ratio is calculated by dividing its outstanding share by its annual revenue.

A good example of this would be to evaluate Amazon. As it is a huge company it grows very fast because it keeps profits low.

Generally, if this ratio is below 2 then the company is doing great. However, like with the P/E ratio you have to compare it to the industry‘s average.

You can easily find these metrics in Yahoo Finance and investing.com. Generally, I check financial information from Yahoo Finance, but investing.com shows you industry averages of these ratios in one place.

Price To Book Ratio (P/B)

Price to book ratio shows the company‘s book value per share. It‘s calculated by dividing book value by outstanding shares.  A company‘s book value is calculated as assets minus liabilities.

This ratio is best used for companies that have a lot of assets like banks and financial institutions.

Generally, you want to ratio to be below 1 but you have to compare it to industries average ratio.

To find out more about ratios I suggest reading Investment checklist by ‘Invested‘.

3.     Technical Analysis

The third step on how to calculate stock price I wanted to mention is technical analysis. Technical analysis is often referred to as studying graphs and trends of stock prices.

This method is used to identify good trading opportunities by evaluating the stock‘s past performance indicators. Mostly, this analysis is used by day traders or short-term investors.

Personally, I love numbers and it is fun for me to analyze statistics and trends but when it comes to investing I lean more toward value investing principles that Benjamin Graham, Warren Buffer, and Peter Lynch suggest.

By this thinking it can be more worthwhile to concentrate on doing the fundamental analysis of a company and not care as much for the current technology trends as over 10 years period it makes practically no difference at all.

That being said I also do not like to see my investment going down as soon as I purchase it and see it staying the same or dropping for 1 or 2 years.

Candles and Moving Average

When you do a technical analysis I would suggest using Investing.com or Yahoo Finance which already has all the tools you will need for it.

There are 2 main things you should look for when you look for a good time to invest.

Candles

Always change the graph to candles. Green candles mean that the price went up, and red means it went down. The length of the candle shows how much the price has changed over a set period of time. I would suggest using a day for a time interval.

Moving Average

Also, you want to add a moving average to the graph for the whole thing to make sense to you so you could start analyzing. It shows what was the average price for a set period of time. If you use a day interval I suggest setting it to 14 days. By default, investing.com is set to 9.

In the chart above I market all the things, you should press to set the graph to get the same view as me.

The moving average is crossing the red candle from below – once this happens stock price is supposed to start moving down. It means that the current up moving is slowing and it may start going down. You can see it on the left side.

The moving average is crossing the green candle from above – once this happens stock price is supposed to start moving up. It means that the current down moving is slowing and it may start going up. You can see it on the right side.

According to technical analysis, these are the 2 points when you should be buying and selling your investment.

Down Side of Day Trading

If you are using only technical analysis then you will likely be buying and selling all the stocks every day. This requires a lot of your attention and time. Not to say that you will probably be tired from it and it could be hard on you mentally.

When you do trading every day you will actually be gaining or losing money often. Can you really bear it?

You also have to keep in mind that when day trading you will be paying additional costs upon purchase and selling. Moreover, you will have to pay taxes as you gain profit. Whereas with value investing you can hold stocks till the day you want to cash out.

If you want to try though I suggest you do it on an app like Revolut or a similar program that will lower your expenses to almost zero until you want to take the money out to your bank account.

Conclusion On How To Calculate Stock Price

• 3 steps to evaluate stocks are moats, ratios, and technical analysis
• Moats help companies in bad market situations
• Ratios let you know if the current stock price is overvalued
• Technical analysis helps you determine where the stock price is going in a concise period

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In this article I will try to answer the question – is the stock market overvalued and teach you how can you check this yourself. 

According to a great book ‘Invested‘ by Danielle Town and Phil Town you only need Shiller P/E Ratio and Buffet Indicator to see if the stock market is overvalued. 

However, I included all the other indicators that I know of if you wanted a second opinion.

Shiller P/E Ratio

Shiller’s P/E ratio is different from other indicators because it includes 10-year average inflation and cyclically adjusted price to earnings. 

The current Shiller P/E Ratio is 27.73. Its mean is 16.99, median – is 15.90. Right now it is close to the highest it ever was.

Right now it is the fourth time this ratio has increased by over 25 and every other time market crashed a lot. However, this indicator does not tell us when the market will crash. It might be a week, 2 years, or even 3 years, but it will crash.

If you wish to know more about this ratio you can read a book by Robert Shiller called ‘Irrational Exuberance‘.

Buffett Indicator

The buffet indicator is the ratio between the market as a whole and the national revenue. This is one of the best ratios you can look into if you want to know where the market stands at any given moment.

• Buffett Indicator is 158% and according to the exponential trendline, 128% would be considered to be fairly valued. 
• According to Phil Town if the value is around 60% then the market is undervalued and if it is over 100% it is overvalued.
• Warren Buffet himself said that if the indicator is near 200% the market is highly overvalued.

According to this ratio, the market was overvalued for 10 years now. In 2009 the Federal Reserve Bank had an intervention of 4 trillion US dollars that stopped the crash from it being worse. Also, interest rates were lowered to 0. 

I believe that Warren Buffet is not holding to his cash for no reason. At the moment it is hard to find good investments. However, it is possible.

S&P 500 P/E Ratio

We need to check the historic average P/E ratio to the current P/E ratio of the market.

Currently, S&P 500 P/E ratio is 19.71, the mean is 15.99 and the median is 14.91. This suggests that the stock market is overvalued.

Analysts do not like this metric as according to them the value of the market keeps rising, so it does not show the full picture. However, analysts try to find all the reasons to prove that the market is priced fairly.

S&P 500 Earning Yield

This is an inverse ratio to the S&P500 P/E ratio. Earning yield is 5.08%, its mean is 7.28% and the median is 6.71%. The less Earning yield is the more the market is overvalued.

This means that if you invest 100 USD in S&P500 you could expect to receive 5 USD annually from your investment.

This ratio is not conclusive it simply supports the S&P500 P/E ratio. However, it shows that the market is overvalued, but it has a trend to get back to normal levels.

S&P 500 Dividend Yield

The dividend yield right now is 1.70%. Its mean is 4.27% and the median is 4.23%. This indicates that the market is overvalued at the moment.

When stock prices rise it tends that dividends do not rise as fast. If you want to invest in S&P500 for its dividends then it is the worst moment in history to do that. This ratio was lower only in the 2000 crisis.

S&P 500 Mean Reversion

This ratio refers to a stock‘s price and that it will fluctuate around its average over the long term. So, if the market is above the trend it will fall below the trend and if it is below the trend line then it will rise in the future.

According to the historic trendline with added expected growth S&P500 is currently 27% above the trend. So, it is overvalued at the moment.

Interest Rates

The current United States Fed Funds Rate is 4.4%. It has recently been increased a few times. 

This means that the US government decided to make it more expensive to borrow money and by that decrease spending. They did this to fight high inflation rates. Therefore, the US market will stop growing as much and return to a more sustainable growth rate.

This indicates that we should not expect high growth rates for the S&P 500 as we saw for the last couple of years. There are some speculations that interest rates will rise above 5% next year in the US. Of this, the market should slow down even more.

Bond Returns

The US bond returns started rising recently to 3.8391%. In the past year, it has increased by 2.333%. We have not seen such a high rate since the 2008 market crash. 

This is very concerning as bond returns get higher it will be a better (and safer) investment option than the stock market.

When this happens investors tend to sell their stocks and go to the bonds. Therefore, the stock market will decrease in value as the money from it will be pulled out by the investors who would find alternative investment options.

Right now we are going there and this could be one of the reasons that the market will crash as some people leaving the stock market will cause others to see falling prices and because of fear, they would also retrieve their money from the investments crashing the market, even more, creating the snowball effect.

Yield Curve Inversion

In this table, you can see the difference in interest rates between different U.S. Treasury bond yields.

Normally you would see short-term bonds have lower yields than long-term bonds. However, if people expect a stock market crash to happen you can see (like right now) people buying bonds.

At the start of this year bond yield was 2.17% and right now it is 3.98%.

This graph that it is right is a bad sign for the economy and most likely will lead to a bad market crash in less than 2 years.

Market Capitalization to GDP Ratio

Currently, the whole market capitalization to GDP ratio is 133.2%. However, the ratio for the US is skyrocketing at 193.3%.

If the ratio is below 70% then the market is undervalued. If it is above 125% then it is overvalued. This is very similar to Buffer Indicator except for this count for the whole market.

According to the numbers the market is as overvalued as it can be in the US. By this, we could expect a crash.

Sector S&P 500 P/E Ratios and Shiller P/E Ratios

In the graph above you can see averages from the last 13 years and current Shiller P/E ratios by each sector.

By this, you can see that the Energy sector is highly overvalued and you should avoid it.

However, the Communications services sector is highly undervalued.

When you look at the whole market you see that it is overvalued. However, there are 11 main sectors by which you can make a closer look. As it might be a bad idea to invest in index funds at the moment you can probably still find some good investment opportunities by looking at each sector and looking at companies one by one.

In the graph above you can see the Regular P/E ratio at the moment and the average from the last 13 years. 

Again like with the Shiller P/E ratio you can see that the Energy sector is overvalued.

However, the Communication Services sector is less undervalued than Shiller P/E showed us and in fact, the Basic Materials sector might be the one undervalued.

You can use both of these graphs to guide you in the right direction. However, you should look into each company individually. It is possible that you would find some great investment opportunities in other sectors as well.

Is The Stock Market Overvalued?

To put it simply – yes it is very much overvalued and it probably will crash in less than 2 years according to different ratios.

What you should do with this information? Well, it might be a good idea to stock up on cash or choose a different investment idea than to invest in stock market indexes like S&P500.

By looking closer into each section you can see that not all sectors are overvalued at the moment so you might be able to find some stocks that currently are selling at fair prices.

Also, you could look into my alternative investment section or even keep your saving in cash to wait for amazing investment opportunities when the market will crash.

If you want to learn more you can check stablebread.com article.

Conclusion

We answered the question – is the stock market overvalued and the answer is a hard yes. Especially the Energy sector and we can expect a crash soon.

In general, you would not need to look into all these ratios that were mentioned in this article. It is more than enough for most of us to check 1 or 2 ratios to get the picture.

However, I think it is good to know that they are out there and to know how to use them.

According to the book ‘Invested‘ you only need 2 ratios that are very easy to look up and track if you are interested in what current condition the stock market is currently in.

Generally, you can look up only the Shiller P/E ratio which should be around 17 for the market to be priced fairly, or to Buffet Indicator which should be below 100%. If these ratios are higher than that then yes, the market is overvalued.

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