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You can use several methods to determine the fair value of a stock. Throughout
the following sections, I discuss three of the more popular methods of determining
the right price for a stock:
- Fundamental analysis
- Technical analysis
- Market timing
Valuing securities is important to your financial health. Stocks are more difficult
to value than bonds. Bonds have a limited life and a stated payment rate. Common stocks don’t have a limited
life or an upper dollar limit on cash payments. This uncertainty makes stocks
harder to value than bonds. Common stock can be valued in a number of different
ways, but overall, the value of a stock is the present value of all its
future dividends. However, common stockholders aren’t promised a certain
dividend each year. The dividend is based on the profitability of the company
and the board of directors’ decision to pay dividends to stockholders.
The second source of return for a stock is the increased market price of the
stock. If the company decides not to pay dividends and reinvests profits in
the firm, the company’s future profits and dividends should grow. This additional
value should be reflected in a stock price increase in the future.
Fundamental analysis seeks to determine the intrinsic value of securities
based on underlying economic factors. It’s the most widely accepted method
for determining a stock’s true value, which you can then compare to current
prices to estimate current levels of mispricing. Fundamental analysts usually
forecast future sales growth, expenses, and earnings.
Using online tools to value stocks
You can visit the following Web sites for more about fundamental analysis
and valuing stocks:
Global Value Investing with Stock Valuation (www.numeraire.com/
index.html) offers an article that illustrates why stock prices and stock
screens are different from stock valuation. You also find an online discount
cash flow valuator. The valuator uses models based on intrinsic
value for the valuation of common stocks and other investment assets.
That is, the model uses the discounted cash flow approach for determining
fair market value. Results are shown in text, tabular, and graphical
formats.
Stockworm (www.stockworm.com) was developed several years ago by
several academics who were interested in investing and the financial markets.
It offers stock analysis, customizable technical charts, stock screeners,
and portfolio management strategies. Stockworm offers three levels of
subscriptions and a free two-week trial. Analyst membership is $7.95 per
month for stock valuations, comparisons to industry averages, and technical
trading signals. A Manager membership is $14.95 per month for everything
in the Analyst level plus advanced stock screeners and portfolio
tracking. Autoinvestor is $29.95 per month and includes everything on
the previous levels and is geared for investors who want the next level of
automating portfolio buy/sell recommendations. Investors configure rulebased
strategies for long or short selling (for example, buy a stock if it is
in the top 20 results of the screener) and receive daily alerts.
ValuEngine.com (www.valuengine.com) was developed by Yale
University’s Dr. Zhiwu Chen and his team of experts. ValuEngine is a
proprietary model for valuing stocks. ValuEngine products include the
stock valuation model (which determines the fair value of stocks), the
ValuEngine stock forecast model (which forecasts the value of stocks),
the ValuEngine portfolio forecast model (which predicts the likely return
of a portfolio), and the ValuEngine Portfolio Advisor Model (which suggests
ways to maximize the future gains of a portfolio). There are no
charges for stock valuations. Premium membership is $24.95 per month
with a free seven-day trial. Subscriptions include delayed quotes, portfolio
functions, portfolio optimization, advance screening, detailed stock
analyses and forecasting, multistock comparisons, research by analysts,
and benchmark portfolios.
ValuePro (www.valuepro.net) was developed by finance professors
to complete stock valuations based on discounted cash flow. The latest
improvements include the ability to download data. The financial valuation
software, which is $44.95, allows you to download data from the
ValuePro Web site to your computer and to use the ValuePro software
to analyze your investments.
You can also use the ValuePro Online Stock Valuation Service at no
charge. The Online Valuation Service looks up valuation inputs from the
SEC EDGAR database and other free sources. The online valuation model
uses quarterly and annual income statements, balance sheets, and cash
flow statements to calculate the ratios. The calculations are based on
observed historical data. (You can see how yearly data is used for the
outcome.) The model also attempts to look up data regarding analyst
estimates about growth rates. The model then combines these inputs
by using the discounted cash flow valuation method to come up with
a baseline intrinsic value for a stock. You can alter the 19 variables to
update stale data and to fine-tune your long-term fundamentals.
Technical analysis is the study of all the factors related to the supply and
demand of stocks. Unlike fundamental analysis, technical analysis doesn’t
look at underlying earnings potential of a company when evaluating a stock.
In contrast, technical analysis uses charts and computer programs to study
the stock’s trading volume and price movements in hopes of spotting a trend.
Overall, technical analysts don’t care about a company’s fair market or intrinsic
value. According to Block and Hirt (1999), technical analysis is based on
several assumptions:
Market value is based solely by the interaction of supply and demand.
Stock market prices are likely to move in trends that persist for long
time periods. However, there may be some minor fluctuations.
Reversals of trends are caused by changes in demand and supply.
Demand and supply shifts can be detected sooner (or later) in charts.
Chart patterns often repeat themselves.
Technical analysis focuses on stock data analyses and stock market statistics.
Analysts generally utilize a series of mathematical measurements and
calculations designed to monitor market activity. Among other things, actual
daily, weekly, and monthly price fluctuations are analyzed. Technical analysts
are searching for early indicators of pattern changes to capitalize on. Trading
decisions are based on signals generated by charts, manual and online calculations,
computer programs, or their combinations.
If you’re an investor who uses technical analysis, check out these Web sites:
ClearStation (www.clearstation.etrade.com) offers customizable
charting tools to illustrate the basics of technical analysis. Color-coded
trends and standard charts are provided when you type in a ticker
symbol. For beginners, explanations of technical analysis methods are
illustrated with real-life examples.
Investtech.com (www.investtech.com) provides daily updated analyses
and recommendations of more than 15,000 stocks in Europe and the
U.S.A. This Web site is by subscription only. Analyses include trends,
price patterns, and support and resistance levels. A written interpretation
of each chart is also provided. You also find a model portfolio and a
top 50 list with the most interesting stocks. For examples of reports and
subscriptions prices, check the Web site.
ProphetNet (www.prophet.net), with your free registration, provides
you with basic service. Basic service includes 40 years of interactive
charting, 20-days of intraday data for each security, the ability to save
two chart styles, 24 technical studies, five custom sets, draw/save trendlines,
access to watchlists, flip charts, two portfolios with 100 transactions
per portfolio, risk/reward analyses, delayed market data, and 30
results for your chart toppers market scans. You can also create and edit
notes. The bronze level is $14.95 per month (or $149.50 per year). The
bronze level includes access to everything in the basic level plus quotes,
java-charts, snap charts, watchlists, portfolios, delayed streaming intraday
charts, Marketmatrix streaming quotes, chart toppers market scans,
Prophetscan real-time custom scanning, mini-charts, and notes. The next
two levels include more bells and whistles. The silver level of service is
$24.95 per month (or $249.50 per year), and the gold level of service is
$39.95 (or $399.50 per year.) You can take advantage of a seven-day free
trial. See the Web site for details.
Technical analysis software
Technical analysis requires large amounts of information (usually historical
price and volume data) that you can manipulate with technical analysis software
programs. Some programs are designed for different types of securities
and for specific indicators and markets. Additionally, some programs are
designed for beginners, while others are for professionals. Here is a short list
of available programs:
Equis MetaStock (www.equis.com) offers MetaStock Professional, which
analysts sometimes refer to as the granddaddy of technical analysis software,
for $1,695. (See the Web site for details.) The Web site includes
back issues of the Equis newsletter, as well as files of tips, system tests,
and custom formulas for use with the software.
Insider TA (www.stockblocks.com) uses box charting to highlight each
trading period’s volume and high and low prices. Insider TA costs $129
for the Standard version and $229 for the Pro version. A downloadable
demo is available at the Web site.
Stable Technical Graphs (www.winterra.com) is a Windows-based program
that analyzes stocks, bonds, commodities, mutual funds, indexes,
and options. Stable Technical Graphs costs $59.95 and offers a downloadable
full product version for a 30-day trial.
VectorVest (www.vectorvest.com) uses fundamental valuation and
technical analysis to rank more than 8,000 stocks each day. Stocks are
ranked for value, safety, and timing, and VectorVest gives a Buy, Sell, or
Hold recommendation on every stock, every day. Go to the Web site to
sample the program. Just enter the ticker symbol of the company you’re
analyzing. The special trial offer is for five weeks and costs $9.95.
Subscription prices vary.
Market timing
The underlying theory of market timing is that you purchase stocks when
prices are low and sell when prices are high. The market timing strategy is
based on reams of historical data that are used to discover patterns and relationships
that affect investment returns. Market timing software uses this
data to detect or anticipate changes in market patterns. Market timers note
that the market can underperform for long periods of time. This low performance
can reduce returns for buy-and-hold investors who decide to go ahead
and sell before the next upswing. In contrast, market timers attempt to time
the purchase and sale of their securities to coincide with ideal market conditions
based on their predictions market cycles.
The biggest problem with market timing is the need to predict when to get
into the market and when to get out of the market (in addition to ensuring
that the timing strategy will make enough increased returns to offset trading
costs). A buy-and-hold strategy makes certain that the investor is in the
market for the days with the biggest gains. Market timers may be out of the
market during these times. For more information about market timing, check
out FirstCapital Corporation (www.firstcap.com).
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Disclaimer
