Wednesday, August 31, 2011

How to Evaluate the Value of Shares

Evaluating a company before investing in its shares calls for a lot of parameters to be taken into account. The value of shares is dependent on the past performance of the company, the competitive advantage it enjoys in its business, financial performance and many other parameters that adds value to the share.

Assuming that you have already decided on the name of the company you want to invest in. The next step is to evaluate the value of share of this company that will help you decide that whether at its present value it is worth buying.

The first indicator that can help investors to decide on the value of shares is its balance sheet. But value of shares are not only dependent on balance sheet but also on its order positions, profit margins which is available on income statements.

Evaluating the value of shares can be done by asking the most basic question investing that “is this share overvalued or undervalued”? Congratulations, now at least you know what is that one question that can make small investors become like Warren buffet.

Timing the purchase of shares is the most crucial element of value investing, because the objective of investing is to buy value shares at an undervalued price.

A financially strong company whose stocks are undervalued at a certain instant of time will not remain undervalued for a long time. The value of share follows the performance of business. Now we will ask the second most important question “how an investor will know that the present market price of share is overvalued and undervalued”?

There are many tools vide which investors can evaluate the value of share. The best tool which has been used by Mr. Buffett to for buying value stocks is called “intrinsic value” calculation rule. Intrinsic value of shares can be calculating by accurately forecasting the future earning and dividends receivable.

Earnings per share (EPS) is one parameter which investors use to tract the performance of shares. There is also another scenario where EPS has increased to a very high value, in such a case company will surely issue dividends to its shareholders.

Calculating the intrinsic value can be categorized into the following broad steps:

Step1 – Estimate the earning per share (EPS) for the next five years.
Step2 – Estimate how much company will disburse its earnings in terms of dividends
Step3 – Estimate the future market value of stocks in terms of the income you have evaluated in step1 above.
Step4 – Finally calculate the present value of future market price if stocks. If the this value is higher than the present market price go for it.
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