What Is Common Stock Valuation?

Kenneth W. Michael Wills

Common stock valuation is the processes, methods and models used to determine the value of a common stock issue by a company to the public. Valuation typically refers to the value assigned to a stock from both the perspective of the seller and the buyer. With value there are several types, though intrinsic value is most commonly relied upon to figure the valuation of common stock. Through the purchase of stock shares on public exchanges or directly from the company if allowed, the public can invest and gain part ownership in a firm through common stock. There are several models used to figure valuation, but each method often relies on subjective assumptions built into the equations, thus resulting in subjective values.

Determining a method for valuation of shares in a company can be done in a variety of ways.
Determining a method for valuation of shares in a company can be done in a variety of ways.

One primary model of common stock valuation is the dividend valuation model. This particular method seeks to ascertain a stock’s value based on potential future cash flow and making assumptions about present values based on those future gains. Earnings model is another method deployed by some analysts to determine the value of a stock. Dividing a company’s earning into two categories — current earnings and growth earnings — the analyst will leverage that information to discern present value. Although common, however, these methods to common stock valuation are just a few among several.

Free cash flow model takes into account all cash leftover after the firm has paid out all operating expenses. Thereafter, the net-operating profit derived is then added to future cash flows. Additionally, all non-operating assets are added in as well to determine the overall profitability of the firm and outstanding shares. Once that figure is achieved, the model will take into account equity by subtracting all debt from the value of the preferred stock. In order to get the value of the common stock, all outstanding shares are divided by the equity.

Stock analysts also find some methods very easy to deploy, and though often used they are more highly subjective than other valuations methods. One such method is the relative valuation model. This model approaches common stock valuation from the perspective that one company should be valued similarly to another company in the same industry. Expedience makes such quick assessment popular, though often inaccurate due to a number of factors underlying the value of a company and its stock. Usually, one of the main reasons opponents to this method resist it is because companies seldom are really comparable even if they are in the same industry.

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