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How to Value a Stock with Better Methods?

Views 5243Nov 1, 2023

Valuation Practice: How to factor in the broad market and the sector?

In previous lessons, we discussed the definition of valuation and different valuation methods. Now, let's put them into practice.

A stock's value does not stand alone. It connects to the broad market and the company's sector.

Liquidity and interest rate levels are two major factors affecting the valuation of the whole market. A loose monetary policy, characterized by lower interest rates, increases the money supply, which lowers borrowing costs. As a result, more cash might enter the stock market, driving up stock prices and the broad market's value.

The value of a sector depends on its growth potential, growth rate, penetration rate, policies, etc. For instance, electric vehicles far outstrip fossil fuel cars in growth potential and growth rate. That's why we have seen higher valuations for EV companies than for conventional automakers on average in recent years.

How to value the broad market and a given sector? Suppose we use the P/E ratio. The value of the broad market refers to the average value of all constituent stocks. So we divide the market values of these stocks by their net earnings. Similarly, a sector's value is the average value of all listed companies in this sector. The average value is their market values divided by their net profits.

After figuring out the value of the broad market and the sector, we can assess the results with their percentile rank relative to historical data. If the current value of the market and the sector are higher than most historical levels, the stock we study could have a higher value. Conversely, if the market and the industry have lower values relative to their historical levels, the stock may be valued lower, too. You can visit websites that track the stock market to view the general market's value and a sector's value compared to their historical levels.

In addition to the value of the broad market and the sector, we need to factor in their trends, which can influence the valuation premium.

When the market and the sector move upward, the market sentiment is bullish, and investors flock in. In that case, stock values may be higher than average.

When the broad market and the sector go downhill, the bearish market sentiment, coupled with capital shortage, may drag down stock market value.

To summarize, when valuing a stock, we need to consider the broad market, the company's sector, and the trends. Besides, valuation is a dynamic process. It should be constantly adjusted according to changes in the market and business operations.

This marks the end of our valuation series. We hope this course is useful to you. Wish you all success in investment.

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