Stock Valuation

Stock Valuation: Finding the True Worth of a Company 🏷️

Imagine you’re at a giant toy store, and every toy has a price tag. But here’s the secret: the price tag doesn’t always match how good the toy really is! Some toys are overpriced (not worth it), and some are hidden gems (amazing value). Stock valuation is like being a treasure detective—you learn special tricks to figure out which companies are truly worth buying.

The Big Picture: Why Do We Value Stocks?

Think of buying a stock like buying a lemonade stand. Would you pay $1,000 for a stand that only makes $10 a year? Probably not! But what if it makes $500 a year? Now that’s interesting!

Stock valuation = figuring out if the price matches the value.

Let’s learn 8 powerful tools that help us become treasure detectives!

1. Price to Earnings Ratio (P/E Ratio) 📊

The Story

Imagine two kids selling cookies:

• Kid A sells cookies for $20, and each cookie earns $1 profit
• Kid B sells cookies for $20, and each cookie earns $4 profit

Which is the better deal? Kid B! You’re paying the same price but getting more earnings.

The Formula

P/E Ratio = Stock Price ÷ Earnings Per Share

What It Means

Real Example

Company: Apple Juice Co.

• Stock Price: $100
• Earnings Per Share: $5
• P/E = 100 ÷ 5 = 20

This means you’re paying $20 for every $1 the company earns. Is that good? Compare it to similar companies!

Quick Tip 💡

Low P/E isn’t always good (company might be struggling). High P/E isn’t always bad (company might be growing fast). Always compare to similar companies!

2. PEG Ratio: P/E’s Smarter Cousin 🚀

The Story

Two lemonade stands both have a P/E of 20:

• Stand A is growing 5% each year
• Stand B is growing 25% each year

Same P/E, but Stand B is growing 5x faster! The PEG ratio helps us see this.

The Formula

PEG = P/E Ratio ÷ Growth Rate

The Magic Number

Real Example

Fast Pizza Inc.

• P/E Ratio: 30 (seems expensive!)
• Growth Rate: 30% per year
• PEG = 30 ÷ 30 = 1.0

Even though P/E is high, the company is growing so fast that it’s actually fairly priced!

3. Price to Book Ratio (P/B Ratio) 📚

The Story

Imagine you could buy a toy box filled with $100 worth of toys. Would you pay:

• $50? Great deal! (P/B below 1)
• $100? Fair (P/B = 1)
• $200? Only if those toys are magical! (P/B = 2)

The “book value” is what the company owns (buildings, machines, cash) minus what it owes.

The Formula

P/B = Stock Price ÷ Book Value Per Share

When It’s Most Useful

✅ Banks and financial companies ✅ Companies with lots of physical stuff ❌ Not great for tech companies (their value is in ideas, not things)

Real Example

Solid Bank Corp.

• Stock Price: $40
• Book Value Per Share: $50
• P/B = 40 ÷ 50 = 0.8

You’re buying $50 worth of stuff for only $40! 🎉

4. Price to Sales Ratio (P/S Ratio) 💰

The Story

Some young companies don’t make profits yet (they’re still growing). But they DO make sales! P/S helps us value these growing companies.

Think of a new ice cream shop. It sells $10,000 of ice cream but spends $12,000 on supplies (no profit yet). We can still see if the price makes sense based on sales.

The Formula

P/S = Stock Price ÷ Sales Per Share

Or for the whole company:

P/S = Market Cap ÷ Total Revenue

The Numbers

Real Example

CloudTech Startup

• Market Cap: $500 million
• Annual Sales: $250 million
• P/S = 500 ÷ 250 = 2.0

Investors are paying $2 for every $1 of sales. For a growing tech company, this might be fair!

5. Enterprise Value Metrics 🏢

The Story

Imagine buying a house:

• The house costs $300,000
• But it has a $100,000 mortgage (debt)
• And $20,000 cash in a safe inside

True cost = $300,000 + $100,000 - $20,000 = $380,000

Enterprise Value works the same way for companies!

The Formula

EV = Market Cap + Debt - Cash

Why It Matters

Two companies might have the same stock price, but one has massive debt. EV shows the TRUE price to buy the whole company.

Common EV Ratios

EV/EBITDA (Enterprise Value ÷ Earnings Before Interest, Taxes, Depreciation, Amortization)

Real Example

MegaStore Inc.

• Market Cap: $1 billion
• Debt: $300 million
• Cash: $100 million
• EV = 1,000 + 300 - 100 = $1.2 billion

The true cost to own MegaStore is $1.2 billion, not $1 billion!

6. Debt Ratios: Is the Company Drowning? 🌊

The Story

Imagine two friends want to start businesses:

• Friend A borrows $10 to start a $100 business
• Friend B borrows $80 to start a $100 business

Who’s in more danger if things go wrong? Friend B! Too much debt is risky.

Key Debt Ratios

Debt-to-Equity Ratio

D/E = Total Debt ÷ Shareholders' Equity

Interest Coverage Ratio

Interest Coverage = Operating Income ÷ Interest Expense

If this is below 2, the company might struggle to pay its debts!

Real Example

SafeTech Corp.

• Total Debt: $200 million
• Shareholders’ Equity: $400 million
• D/E = 200 ÷ 400 = 0.5 ✅ Safe!

7. Liquidity Ratios: Can They Pay Bills Today? 💧

The Story

Imagine you have a piggy bank with $50, and you owe your friend $100 tomorrow. Even if you’ll earn $1,000 next month, you have a problem TODAY!

Liquidity = having enough cash RIGHT NOW to pay bills.

Two Key Ratios

Current Ratio

Current Ratio = Current Assets ÷ Current Liabilities

Can they pay bills due within 1 year?

Quick Ratio (Acid Test)

Quick Ratio = (Cash + Receivables) ÷ Current Liabilities

Can they pay bills WITHOUT selling inventory?

A quick ratio above 1 means they can pay bills even without selling products.

Real Example

QuickMart Store

• Current Assets: $300,000
• Current Liabilities: $200,000
• Current Ratio = 300 ÷ 200 = 1.5 ✅ Healthy!

8. Economic Moat: The Castle’s Defense! 🏰

The Story

In medieval times, castles had moats (water trenches) to keep enemies out. The wider the moat, the safer the castle!

Companies have “moats” too—things that protect them from competitors.

Types of Moats

graph TD
    A["Economic Moat Types"] --> B["Brand Power"]
    A --> C["Network Effect"]
    A --> D["Cost Advantage"]
    A --> E["Switching Costs"]
    A --> F["Patents/Secrets"]

    B --> B1["Example: Coca-Cola"]
    C --> C1["Example: Facebook"]
    D --> D1["Example: Walmart"]
    E --> E1["Example: Microsoft"]
    F --> F1["Example: Pfizer"]

The 5 Moat Types Explained

How to Spot a Moat

Ask these questions:

1. Can competitors easily copy this company? (No = Good moat)
2. Have they kept competitors away for 10+ years? (Yes = Wide moat)
3. Can they raise prices without losing customers? (Yes = Strong moat)

Real Example

SuperSearch (Imaginary Google)

• Network Effect: More users → more data → better results → more users
• Brand Power: “Just SuperSearch it” is a common phrase
• Switching Costs: All your emails, documents, photos are there
• Moat Width: VERY WIDE! 🏰🌊🌊🌊

Putting It All Together: Your Valuation Toolkit 🧰

Think of each ratio as a different lens:

graph TD
    A["Is This Stock Worth Buying?"] --> B["P/E Ratio"]
    A --> C["PEG Ratio"]
    A --> D["P/B Ratio"]
    A --> E["P/S Ratio"]
    A --> F["EV Metrics"]
    A --> G["Debt Ratios"]
    A --> H["Liquidity"]
    A --> I["Economic Moat"]

    B --> J["Cheap vs Expensive?"]
    C --> K["Worth the Growth?"]
    D --> L["Assets Value?"]
    E --> M["Revenue Value?"]
    F --> N["True Price?"]
    G --> O["Too Much Debt?"]
    H --> P["Can Pay Bills?"]
    I --> Q["Protected from Competitors?"]

The Treasure Detective’s Checklist ✅

1. Check P/E: Is it expensive or cheap vs. similar companies?
2. Check PEG: Is the growth worth the price?
3. Check P/B: Are you paying for real assets?
4. Check P/S: For growing companies, is revenue valued fairly?
5. Check EV: What’s the TRUE cost including debt?
6. Check Debt: Is the company safe or drowning?
7. Check Liquidity: Can they pay today’s bills?
8. Check Moat: Are they protected from competitors?

Remember This Forever 💎

Price is what you pay. Value is what you get. — Warren Buffett

No single ratio tells the whole story. Use them ALL together, like pieces of a puzzle!

Happy treasure hunting! 🔍✨