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Essential Stock Valuation Elements

|Includes: Cigna Corporation (CI), NKE
Summary

No valuation method is 100% accurate all of the time, but value investing has a proven track record of being profitable over the long term.

There six main points I look at when valuing a potential holding and they are all easily accessible and easily understandable.

By using this combination of data you can successfully extract key statistics that will tell you whether a company has the potential to grow or not.

I am going to preach what I practice here and tell you a little bit about value investing, which in my opinion ties in with growth investing because if you see value in a company you are surely expecting it to grow, many will disagree still. This stock investing strategy can be used by stock market beginners and expert investors, it is very versatile.

My investment strategy is to look for growth in revenues, growth in EPS, good balance sheets, good income statements, and a lower than average P/E ratio. It sounds like a lot but it is all super easy for you to find and super valuable in your valuation process.

Four out of 5 data points can be found on Yahoo Finance, but if you have a brokerage account you should be able to find this data in any basic research section.

EPS/Revenue

Sticking with Yahoo Finance as an example, you can find EPS and revenue growth on the analysis tab after inserting your company name or ticker. You always want to make sure you are looking at the current full-year data. It will be laid out very easily to read, showing the current data, the data from one year ago, and the growth percentage. You are looking for any signs of growth in these two show that the holding is not just sitting still. Scroll down to the bottom of the page and it will show you expected growth long term, you, of course, want to see growth here as well.

Income Statement/Balance Sheet

Income statement and balance sheet can be found on the financials tab. The Income statement will show you key data points like net income, EPS, and EBIDTA is available but isn’t a data point that I use often or heavily. Yahoo will show you the last 4 years of data so it is easily comparable, you, of course, want to see that these things are growing steadily. The balance sheet is going to show you assets and liabilities. Go ahead and look straight at the total assets vs. total liabilities, you want to see that a company has more assets than it does liabilities because if the company doesn’t have enough money to pay of their debts things start to get a lot less fun. Some companies cut it close and they do fine, some companies have a wide margin of safety and still fail, but it is always good to look and see what you are dealing with.

P/E Ratio

Lastly, you want to check and see what the P/E ratio is looking like. I only buy companies with lower than average P/E ratios. You can find the Current P/E ratio by taking the current market price and dividing it by the full-year estimated EPS you looked at earlier. If a company has a market price of $10 and a full year EPS of 2, the P/E would be 5. That easy enough, right?

Next, you need to find the average P/E. Think can be found with a quick google search of “what is the average p/e ratio of _____?”, one of the top links should be from Guru Focus, a top research company, they will give you a little diagram of the current and average P/E ratio of the company, I have found that their current P/E doesn’t always match up with mine so make sure to calculate that on your own still. The page will show you something like this.

Now you can compare if the current P/E is higher, lower, or equal to the average. If it is equal to or higher than the average, that is a red flag. That indicates to me that the company is overvalued and is due for a reversion to the mean, which would mean a lowering in price. If the P/E is lower than average, that shows me that the stock has to reverse to the mean, but this time in an upward projection.

Target Price

While we are looking for a lower than average P/E, we want to make sure that it is low enough to grow an adequate amount, I would hate to put my money into an investment that is going to grow $1/share when I could have put it into a company that is set to grow $5/share.

The way we find out how much a company is set to gain is by calculating the target price, it is super easy to find because you have already found all of the data needed to calculate it. The two pieces of data you will need are the average P/E ratio and the current full-year EPS.

Let’s use Cigna Corp. (which I just analyzed in a previous article) for example, Cigna closed on Friday with a market price of $149.48. CI has a full-year EPS estimate of $16.80 and an average P/E of 14.6x, you are going to multiply these two numbers and that is going to give you your target price.

14.6x X $16.80 = $245 target price

That is a $95 potential growth if the company were to reach the target price, which I fully expect it to do.

Now that is a number worth investing my money into! That is a potential gain of 63% if that doesn’t excite you I don't know what will!

You know officially have everything you need to value a company properly. Of course, if you have other things you use by all means use them, but it doesn’t hurt to look at as many statistics as possible!

I have used this technique successfully and it would be selfish of me to keep it all to myself. Use it to your full advantage and enjoy your investment journey!

Disclosure: I am/we are long CI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no position in Nike Inc. NYSE: NKE