How do I Determine Stock Values?
True Stock Value = Present Value of Expected Cash to Shareholders
The True Stock Value of a business is the present value of the net assets --known as assets minus liabilities-- a business is expected to generate over its life that will eventually be turned into cash for shareholders.
The True Stock Value of a business is the sum of its Value From Past Results and Value From Expected Future Results.
Value From Past Results which is defined as the per share value of assets excluding intangible assets --excluded since the accounting values of those assets do not accurately reflect their expected eventual cash value to the shareholders-- minus liabilities as shown on the business' latest annual balance sheet.
The net assets a business is expected to generate from future transactions is called its Value From Expected Future Results which is defined as the per share present value of the expected assets minus liabilities to be generated from future transactions also known as the discounted value of future earnings.
An investor needs to roughly project the future earnings of a business to determine its Value From Expected Future Results. An investor can roughly project the future earnings over the long-term by starting with the past earnings and making adjustments to the future earnings to reflect the expected changes to its competitive position.
Future earnings are discounted to get their present values because the further in the future Earnings are projected to occur, the least valuable they are in the present due to the time value of money and the general risk that they won't occur. The rate that future earnings are discounted at is the current 10-year US Treasury bond yield plus an earnings risk premium of 7%. The 10-year US Treasury bond yield reflects the rate the market is currently offering for the time value of money for a virtually risk investment and the 7% earnings risk premium is the general risk that earnings won't be realized due to macroeconomic factors that are unpredictable such as wars, natural disasters, and abnormal governmental mismanagement.
The True Stock Value shouldn't be interpreted as a precise gauge of value but rather as a general estimation of value. The difference between the current stock price and the True Stock Value is assessed to determine if the stock is overvalued or undervalued. A stock trading within 20% of its True Stock Value is considered slightly overvalued or slightly undervalued; a stock trading within 20% to 40% is considered moderately overvalued or moderately undervalued; and a stock trading further than 40% from its True Stock Value is considered highly overvalued or highly undervalued. The further the True Stock Value is from the current stock price, the better the expected return for either buying long or selling short the stock.
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