Intelligent Investor's Notes: The Best Stock Valuation Method

There are overwhelming number of valuation techniques but there is no one method that is best suited for every situation - Each stock is different, and each industry sector has uique properties that may required varying valuation approaches.
2 categories of Valuation Methods:-

Absolute Valution - attempt to find the intrinsic or "true" value of an investment based only on fundamentals - mean you would only focus on such things as dividends, cash flow and growth rate for a single company, and not worry about any other companies. E.g. Dividend Discount Model, DCF, Residual Income Models and Asset-based model.
Relative Valuation - comparing the company in question to other similar companies. It calculate multiples or ratios (e.g. P/E), and compare them to the multiples of other comparable firms. It is a lot easier and quicker to do than the absolute valuation methods.

It calculates the "true" value of a firm based on the dividends the company pays its shareholders.
Dividends represent the actual cash flows going to the shareholder, thus valuing the present value of these cash flows should give you a value for how much the shares should be worth.
Pre-Requisite

This method only can value a company that pay dividend.
The dividend should be stable and predictable. (typicaly a mature blue chip company)

Check EPS growth rate, dividend growth rate, and dividend payout ratio to forecast the future dividend payout.

If a company doesn't pay dividend or its dividend pattern is irregular - move on to check if the company fits the criteria to use the DCF.
It use a firm's discounted future cash flows to value the business.
It can be used with a wide variety of firms that don't pay dividend, and even for compnies that do pay dividends.
Two-Stage DCF model is the most commonly used form - the free cash flow are forecasted for five to ten years, and then a terminal value is calculated to account for all the cash flows beyond the forecast period.
Pre-Requisite

Mature firms that are past the growth stages that have the ideal cash flows suited for the DCF model; Many small high growth firms and non mature firms will be excluded due to large CAPEX.

If you are not able to value the company using any of the othermodels, or if you simply don't want to spend time crunching the numbers.
It simply compares the stock's price multiples to aa benchmark to determine if the stock is relatively undervalued or overvalued.
It based on the Law of One Price - two similiar assets should sell for similiar prices.
It can be used in almost all circumstances due to the vast number of multiples that can be used, e.g. P/E, P/B, P/S, P/CF
P/E is the most commonly used - it focuses on the earnings of the company. It can be used on all publicy traded stock (you need stock price) which generating positive earnings (because a compare of -ve P/E would be meaningless) with a strong earning quality (earnings should not be too volatile and the accounting pratices used by management should not distor the reported earnings drastically)

Investor will perform several valuations to create a range of possible values or average all of the valuations into one.

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Intelligent Investor's Notes