This article will evaluate several ways of deciding how much a company share is worth, based on a few traditional methods. It does so by comparing several often used, and taught equity valuation methods. Should be noted that each method has its ups and downs, depending on the specific industry and even company.

For this article we assume less knowledge than usual, to make this more of a template.

Growth based

This method assumes that the corporate entity is growing to become a lot bigger, resulting in a value that greatly exceeds any of its current data. A possible measure for estimate would be its direct competitor and a pro rate value compared to estimated sales when it stops growing.

Using potential growth as a basis is partially a gamble: There are no prior results from this specific company, they still have to prove themselves as a success. This risk is partially mitigated by serial entrepreneurs who have successfully turned a massive profit, but that does not guarantee the same result. Even in the same industry changes happen, making it possible for the entrepreneur’s formula to fail.

The only way to successfully invest in these companies is by looking at everything they provide and replicating their research.

EPS

Clean and simple; you take how much profit a company has and divide this by how many shares there are outstanding*. This would have to be multiplied by something, usually the industry average.

The problem with these is dilution from sheer number of shares: Companies can issue new ones or buy up outstanding stock as they see fit. Also, it does focus heavily on short term profiteering, against long term profit which is not yet reflected in earnings. However it is a good option for entities that are unlikely to grow further, that have stabilised at a good place.

Cash

If there is one universal truth it is that cash is king. In a few rare industries companies are valued solely on how much they have of it. All other assets are ignored.

This is not really the best way to value most corporation; since anyone can, on mid term, simply hoard cash and use it as collateral for further loans, to be used as a short term boost to cash. This actually is a good example of pump and dump: Share price is pumped up due to excess cash, after which those one the inside sell their equity, as prices fall due to this all being the result of a loans and nothing more.

Naturally there is an upside to a huge pile of cash money: There is a buffer for both failed projects and resources for new project, growth is a very real prospect for these entities. When those projects succeed, the company is unlikely to stay valued for only its cash.

Book value

We take the above cash base and add all other listed assets; this is how much the company is worth on paper and simply copy it to get their market value.

There is nothing wrong with this method; you take a book by its cover and say that is what it is worth. This method suits mainly starting companies or those with uncertain prospects. The main issue is, presumably, the lower valuation compared to profit based, but it is still better than cash only. A flaw in this method is assuming everything has net value; most entities have debts and starting or struggling corporations are no exception. A better method in this case might be to value shareholders equity (in its basic form assets minus debt) only, as that is the true value of what you are buying, plus a reserve or two.

There is a risk reward possibility here: If a starting company is bought at asset value and starts turning regular profits, it will increase in value.

 

*Outstanding shares differs from total shares; sometimes companies buy them back to boost EPS. This does show the popularity of using EPS as a enterprise valuation tool. It is also possible to issue more shares, though that does require shareholder approval. The author has seen several cases of other parties voting against his, most of theirs as well, best interest with over 80%; so do not assume that other shareholders will vote for something that generates more profit. Shares are also sometimes created to give to employees, which can be difficult to monitor as a small shareholder.