During better days, investors seem to forget that better days will soon end.
They tend to pay higher amounts for profits.
But in times of bear days, investors tend to react and may not shed cash for anything.
Stock price is determined through the so called "valuation" - the price of the stock according to a given criteria.
Price/earnings (P/E) ratio This is common formula that is being used by everybody.
It is calculated by dividing the current price per share of the stock by earnings per share.
Again, earnings per share computation are relative, but the most logical and to be used is the P/E of the past four quarters because those earning have already been recorded.
However, investors tend to always go for estimated earnings of the future period which can be taken from some financial websites.
Analysts at Wall Street generally calculate earnings-per-share estimates for both the current fiscal year and the next year to be used for computation of P/E, though it is not guaranteed that the estimate will be attained by the company.
Basically, the P/E ratio serves as a gauge whether a stock is overvalued or undervalued.
It must be kept in mind that the P/E can't be a gauge of an investor's decision whether to buy or sell stocks.
In stock valuation, price is often influenced by expectations of future performance.
Company whose stock are valued higher may be justified if its earnings are growing faster than the others.
Determining an appropriate P/E may depend on the growth pace of a company.
In general, the market chooses a company with a faster and greater growth potential, thus, valuing that company with a higher P/E.
Another computation to make a comparison of P/Es and growth rates is the PEG ratio which is the P/E estimates for the current year divided by the long-term growth rate.
For example, a company with a P/E of 34 and growing at a rate of 20% has a PEG of 1.
7.
An investor may go for stock with PEG that's close or lower than 1.
0, an indication that it is trading along with its growth rate.
But if you think the company has greater potential, you may be willing to pay more.
Investors must also be aware that not all rock-bottom P/Es are trading along with its growth rate, because some companies, like the cyclicals are ill-fated to low valuations because their earning growth goes up or down with the economic upturn or downturn.
Another useful formula for investors is the Price/Sales ratio which determines how much they will be paying for revenue or sales -- which are being used interchangeably.
Price/Sales ratio is the result of stock price divided by the total sales per share for the past 12 months.
Like P/E, there are also revenue estimates for the next fiscal year which are posted on financial websites.
Fast growing companies tend to get the highest valuation in Price/Sales ratio.
The company's book value is the total assets minus its total liabilities and intangible assets.
This is the worth of the assets left after paying off all the creditors in time of liquidation.
The book value is also known as "shareholder's equity" on the balance sheet of the company.
When you divide this aggregate total by the number of shares outstanding the result is the book value per share.
This computation poses a conservative measure in determining whether a company is under- or over- valuing its true capacity and strength.