How to Calculate the Valuation of a Company?

How to Calculate the Valuation of a Company?

Investment in the stock market requires basic knowledge of stock valuation to get the right numbers. Every Investor should check upon key factors that show the financial growth of the company & prospects. To begin as an investor in the stock market, they can start with how to calculate valuation of a company.

Published on 11 July 2023

Valuation of company is a popular technique for determining the correct stock’s worth. It might look complex; however, the right estimation is a safety measure to save from hefty losses. It also helps investors to check up on the overvaluation or undervaluation of the company. To make the doubt of investors about how to calculate the valuation of a company can be done using multiple methods.

Different Methods for Valuation of a Company

To assess the correct valuation of company, let’s look at the most popular valuation techniques used in the market.

●      Asset Approach

The easiest way to begin with the valuation of companies is to derive their Net Asset Value (NAV). To proceed with the company valuation calculation, investors should get the true figure of the fair value of depreciating and non-depreciating assets. As the fair value differs for both classified assets. Once we get the fair value of assets, calculating NAV would be a far easier task.

The formula for calculating NAV:

*Net Asset Value = Fair Value of all the Assets of the Company – Sum of all the outstanding Liabilities of the Company

Although there are other components like intrinsic cost & replacement cost that might affect the fair value of assets, the asset-based approach is mostly a compatible valuation technique for companies with more tangible assets than intangible ones.

●      Income Approach

The popular valuation technique Discount Cash Flow or DCF is known to be the income approach. Under this method, investors use the technique of discounting the future cash flow to determine the right value of the company. This discounting can be done using the cost of the company’s capital asset.

One of the key techniques for financial analysis is the Income approach. Investors get the right calculation of undervalued or overvalued estimations.

●      Market Approach

This approach is also famous for the term relative valuation method & is considered to be the standard technique for company valuation. This approach uses key metrics, such as the PEG ratio, P/E or P/B ratio, and EV, to determine the company value. Also, calculating these metrics comes under financial statement analysis.

Let’s highlight these key financial ratios used to find the correct valuation & analysis.

Earning Before Interest, Tax & Amortisation (EBITDA)

One of the most common financial ratios helps to derive the correct company’s valuation. Earnings are derived before calculating tax, interest, or loan amortization to calculate the ratio.

Formula: *EBITDA to sales Ratio = EBITDA/ Net sales

The final figure should always be less than 1, as tax, amortization & interest are considered from earnings.

Price to Book Value Ratio (PBV Ratio)

It is one of the most traditional methods used for calculating the valuation of company - PBV ratio. This metric doesn’t represent the company’s future earnings & intangible assets. For instance, banking companies use the method as their earning depends on calculating the asset’s value.

*PBV Ratio = Stock Price/ Book Value of Stock

Price to Sales Ratio (PS Ratio)

This ratio helps to derive a better valuation of a company. Under the metrics, the sales figure doesn’t get distorted by the capital structure. There are two ways to calculate the ratio: one is by dividing the company’s share price by the total sales & another way is to divide the share price by the company’s annual net sales.

*PS Ratio = Share price/ Total sales or Stock Price/Net Annual Sales

Price to Earnings Ratio (PE Ratio)

The ratio is calculated by dividing the stock price by earnings per share. This is the standard technique to determine whether the company is undervalued or overvalued. It is based on the profit after tax or PAT to get the accurate value of the PE ratio. However, PAT distorted multiple accounting methods and might not derive an accurate value.

*PE Ratio = Stock Price/Earnings per share

Why Do We Calculate a Company’s Valuation?

Once the investor gets the correct figure of the company’s market value & the intrinsic value, an investor can decide whether to hold or sell the company’s stock. If the company’s market value exceeds the intrinsic value, it should be sold. Otherwise, if the company's intrinsic value exceeds, we should buy the stock.

Valuation stock analysis is essential to determine the true value of the company. If investors invest in an overvalued company, then it might increase the risk of losing capital. Apart from fundamental analysis, the company’s valuation exhibits the accurate investment figure. Analyzing a company's value using the right technique to grow invested money with high profits.

Key Takeaway!

So, through this blog, investors can get an overview of how to calculate the valuation of a company. A little bit of market research can save investors from losing high amounts of money. Investors must be aware of the company's nature & use the right valuation technique to derive an accurate estimation. Investors can take the help of online calculators to assess the valuation of company. 

Chandresh Khona
Team Espresso

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