IFB11: A Complete Guide to to the Most Useful Stock Valuation Methods

Today we are going to talk about stock valuation methods. Andrew has a great ebook that he wrote a while back that talks a lot about how to value a stock. These are methods that I use personally every day .

* A breakdown of the 7 valuation metrics that we use
* P/E ratio and its importance
* P/B ratio and the relevance to value investing
* Debt to Equity is probably the most important ratio

 
Andrew: There are a lot of different ways you can evaluate a stock, there are a lot of different models. I want to talk about some of the simplest ones that you’ll approach, you can always take the subject a bit further. You can talk to experts, they like to talk about things like EV or EV/EBITDA, that is enterprise value to earnings before interest, taxes, depreciation and amortization. You could do a discounted cash flow valuation you can do free cash flow valuations.
There are all these different metrics that someone can use to really value a stock. some of the most basic ones I actually use. We are going to talk about 7 of them and they’re all part of the seven steps that I wrote about in my ebook. IT is also the same 7 metrics I use for my value trap indicator system. All of these combined are what I use to formulate my approach and it’s the exact same method I use to buy every single stock that I buy.
Now, keep in mind you certainly can use one of these. Some people do, you have the Peter Lynch approach where people just strictly look at a PEG ratio, which can be a combination of two of them that we are going to talk about today. You certainly could use just one, there is the Ben Graham approach, which early one was one that Warren Buffett used which he calls the “net, net” approach. Kind of like, the metaphor they use is picking “cigar butts.”
And they really use a price-to-book, more focused on net tangible assets. This is another variation of a valuation method that we are going to talk about today. My whole point is that you could center on any one of these valuations, I argue that when you value a stock, you don’t want a laser focus on making one ratio that much more important than the others. I think you want to take a complete picture approach, understand that there are three financial statements that every single stock needs to post to the SEC.
The SEC puts it on their website and it’s freely available information to us. A lot of investors will look at one little tiny sliver of the financial statements, completely ignore the other ones and get blindsided when they don’t account for things they aren’t looking for.
We are going to look at the whole picture, all seven of these and not so much that they are all excellent but they are all good enough to where you can feel comfortable that number one we are getting a stock at a good price. And number two, that were are getting a stock that has a great business model, and is likely to continue and gives us gains in the future.
The first method valuation method I want to talk about is probably the most common and every single novice investor knows of this ratio. And that is the Price to Earnings ratio or P/E. What this is going to tell us is, if you think about what a business does, the business will basically spend money and they are going to try to make more than they spend, and that difference is a profit.
And profit really becomes the number one goal of the business, which is something that gets lost in the wash.  A lot of people focus on other things, but really at the end of the day, the goal of a business is to turn a profit. Price to earnings ratio helps ensures us that as investors we are getting a fair share of the profits.