What techniques can you use to compare intrinsic stock value to market price?

In the context of technical analysis, comparing intrinsic stock value to market price can help you identify undervalued or overvalued stocks, as well as potential entry and exit points for trading. Intrinsic value is the estimated true worth of a stock based on its fundamentals, such as earnings, growth, dividends, and cash flow. Market price is the current price at which a stock is traded on an exchange. However, there is no one definitive way to calculate intrinsic value, and different techniques may yield different results. Here are some of the most common techniques that you can use to compare intrinsic stock value to market price.

1 Discounted cash flow

Discounted cash flow (DCF) is a method that projects the future cash flows of a company and discounts them back to the present value using a discount rate. The discount rate reflects the risk and opportunity cost of investing in the stock. The DCF method assumes that the intrinsic value of a stock is equal to the sum of its discounted future cash flows. To compare DCF to market price, you can divide the DCF value by the number of shares outstanding to get the intrinsic value per share, and then compare it to the current market price per share.

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Aditya Gandhi
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Discounted cash flow is a way to figure out how much something is worth in the future by considering how much money it could make. It works by taking all the expected future profits and discounts them, meaning it adjusts them to show their value in today's terms. This helps in deciding how much something is worth right now based on what it might earn in the future.

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2 Dividend discount model

Dividend discount model (DDM) is a variation of DCF that focuses on the dividends that a company pays to its shareholders. The DDM method assumes that the intrinsic value of a stock is equal to the present value of its future dividends. To calculate the DDM value, you need to estimate the dividend growth rate and the required rate of return for the stock. The required rate of return reflects the risk and expected return of investing in the stock. To compare DDM to market price, you can divide the DDM value by the number of shares outstanding to get the intrinsic value per share, and then compare it to the current market price per share.

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Aditya Gandhi
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The Dividend Discount Model is like guessing how much a company's stock is worth by looking at how much money it might pay to its shareholders in the future. The Dividend Discount Model thinks that how much a stock of a company is worth today depends on all the money it might pay to its shareholders later on, but we have to change those future money amounts to show how much they're worth right now.

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3 Earnings multiples

Earnings multiples are ratios that compare the earnings of a company to its market price. The most common earnings multiple is the price-to-earnings (P/E) ratio, which divides the market price per share by the earnings per share. The P/E ratio measures how much investors are willing to pay for each unit of earnings. A lower P/E ratio may indicate that a stock is undervalued, while a higher P/E ratio may indicate that a stock is overvalued. However, the P/E ratio should be compared to the industry average or the historical average to account for different growth rates and risk levels. Other earnings multiples include the price-to-earnings-growth (PEG) ratio, which adjusts the P/E ratio for the earnings growth rate, and the price-to-sales (P/S) ratio, which divides the market price per share by the sales per share.

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Aditya Gandhi
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The P/E ratio is like looking at how much you're paying for a share of a company compared to how much money that company is making. If the number is high, it might mean you're paying a lot for what the company earns, and if it's low, it might mean you're getting a better deal.

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4 Book value

Book value is the net asset value of a company, calculated by subtracting its total liabilities from its total assets. Book value represents the amount that shareholders would receive if the company was liquidated. To compare book value to market price, you can divide the book value by the number of shares outstanding to get the book value per share, and then compare it to the current market price per share. A lower market price than book value may indicate that a stock is undervalued, while a higher market price than book value may indicate that a stock is overvalued. However, book value may not reflect the true value of intangible assets, such as brand, reputation, or patents, that are not recorded on the balance sheet.

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5 Relative valuation

Relative valuation is a technique that compares the valuation of a stock to the valuation of similar stocks in the same industry or sector. Relative valuation uses multiples or ratios that measure the value of a stock relative to its earnings, sales, cash flow, or other metrics. Some of the most common relative valuation multiples are the enterprise value-to-EBITDA (EV/EBITDA) ratio, which measures the value of a company relative to its earnings before interest, taxes, depreciation, and amortization, and the price-to-book (P/B) ratio, which measures the value of a company relative to its book value. To compare relative valuation to market price, you can calculate the average or median multiple of a group of comparable stocks, and then multiply it by the metric of the stock you are evaluating. The result is the relative value of the stock, which you can compare to its current market price.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Dr. Tamer Alsayed, CPA, FCMA, CGMA

Experienced CFO & Financial Strategist | CFO OF the 2024 |Top 200 Power leaders in Finance | Financial Strategy & Analysis, FP&A | Capital Allocation, Treasury, Risk Management | Private Equity & Venture Capital
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Discounted Cash Flow (DCF) Analysis: Use DCF analysis to estimate the present value of expected future cash flows generated by the stock. Compare the calculated intrinsic value with the current market price to determine if the stock is undervalued or overvalued. Price-to-Earnings (P/E) Ratio: Calculate the P/E ratio by dividing the stock's market price per share by the earnings per share (EPS). Compare the P/E ratio with industry benchmarks or historical averages to assess if the stock is priced reasonably relative to its earnings potential. Comparative Valuation: Analyze the stock's valuation multiples, such as price-to-sales (P/S) ratio or price-to-book (P/B) ratio, and compare them to similar companies in the industry.

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What techniques can you use to compare intrinsic stock value to market price?

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1 Discounted cash flow

2 Dividend discount model

3 Earnings multiples

4 Book value

5 Relative valuation

6 Here’s what else to consider

Technical Analysis

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What techniques can you use to compare intrinsic stock value to market price?

1

2

3

4

5

6

1 Discounted cash flow

2 Dividend discount model

3 Earnings multiples

4 Book value

5 Relative valuation

6 Here’s what else to consider

Technical Analysis

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