Is there more to a stock price than figuring out the cost of a share? There might be – and there’s more to it than just a number.
Watching the up and down of a stock price on your favorite investment can feel like reading a Sherlock Homes mystery. You’re never sure what’s around the corner, and the next page could spell doom for the protagonist. Or the perfect clue could appear, resolving all the questions and leaving you to bask in the joy of a great story with a satisfying conclusion.
Of course, there’s more on the line with a stock price than there is in a work of fiction, no matter how realistic it may seem. There’s a very real chance the money you’ve invested could gain - or lose - value. But there’s more to a stock’s value than the price of a share.
First of all, stocks do not go up and down because of price point. Stocks go up and down for two reasons: investors like the prospects of a company and buy the stock, thus driving the price up, or they dislike the company’s outlook and sell the stock, thus driving the price down.
While there are investors who buy modest numbers of shares in low-priced stocks, the larger number of shares traded each day are bought and sold by investment firms, mutual funds and other entities that would never make buy and sell decisions based on share price alone. They look at the fundamentals, meaning sales, profit, debt, products, competitors and the like; or technical indicators, meaning price charts, volume of shares traded, etc., neither of which has anything to do with whether the stock costs $12 or $56.
What factors into a stock price
A stock price is based on a number of tangible and intangible factors: the current status of the company, the prospects for the company, market sentiment, economic or political environment and many other factors.
There are many analyses available to find a company’s intrinsic value, but most of these are somewhat complicated. There are a few simpler measures, however, which will provide worthwhile indications of whether or not a stock price is appropriate. The key to using these criteria is to use the right one to assess each type of stock.
The P/BV (price to book value) ratio is calculated by dividing the current stock price by the latest reported book value (or net asset value) per share. The ratio is best used when evaluating companies in the Energy, Materials and Financials sectors.
The P/CF (price to cash flow) ratio is calculated by dividing the current stock price by the latest four quarters of reported cash flow (or change in cash position) per share. The ratio is best used when evaluating companies in the Consumer Discretionary and Industrials sectors.
The P/D (price to dividends) ratio is calculated by dividing the current stock price by the latest annualized quarterly dividend (quarterly dividend time four) per share. The ratio is best used when evaluating companies in the Health Care, Financials and Utilities sectors.
The P/E (price to earnings) ratio is calculated by dividing the current stock price by the latest four quarters of reported earnings (or profits) per share. The P/E ratio is sometimes the least reliable price multiple, because companies adjust earnings per share using different criteria and standards. The ratio is best used when evaluating companies in the Energy, Materials and Financials sectors.
The P/S (price to sales) ratio is calculated by dividing the current stock price by the latest four quarters of reported sales (or revenues) per share. The ratio is best used when evaluating companies in the Consumer Discretionary and Consumer Staples sectors.
The PEG (P/E to projected EPS growth) ratio is calculated by dividing the current stock price by the latest four quarters of reported EPS (earnings) per share, and then dividing the result by projected EPS growth for the next three to five years. The ratio is best used when evaluating growth companies in any of the sectors.
Perhaps the most important advice we can offer when looking at stocks, however, has little to do with stock price.
When looking for good companies that will provide above-average stock-price appreciation and increasing dividends, look for several factors. These factors include strong balance sheets with low debt and lots of cash. We prefer companies that have paid dividends for decades where increases are common. And we check to see if the company is likely to continue to grow during the next several years.
To learn more about investing and setting up your portfolio, download our free report, How to Invest in Stocks: How Stocks Work, How to Calculate Return on Investment and Other Investing Basics.
What questions do you have about the price of stocks? Let us know in the comments.