Smart Military Investor’s Stock Valuation Guide

This blog post will give you a stock valuation formula and stock valuation techniques to help you recognize when a stock is undervalued or overvalued. 

The goal of a Smart Military Investor is to find a well-managed company whose share price is selling for a price that is below actual value. This is like when you are shopping for a new phone and waiting until the next edition comes out so you can get a cheap discount on the earlier addition. The earlier edition is still a great phone, but because the buzz around it has faded away, the price has declined.

Buying cheap stocks in good companies is the best way to grow your investments over time. If you are constantly buying stocks that are overvalued, there is no room for your initial investment to grow.

How to value a stock:

First, you need to find the earnings growth rate of the stock over the past 5 years. To do this, got to Morningstar.com and write down the EBITDA from 5 years ago, and the EBITDA from the most recent year.

Quickly, EBITDA, stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. A deep level of accounting is needed to understand each of those terms. That’s why you want to take the earnings number BEFORE all of those ever come into play. Plus, it also eliminates the chance you are taking earnings figures from companies that use shady accounting practices.

Once you get those figures, input them in this simple formula. I’ll be using Apple’s numbers for this example.

Earnings Growth Formula:

Present EBITDA - Past EBITDA / Past EBITDA

Apple Inc. Example:

73,333 – 58,518 / 58518

= 25.3%

It’s really that easy. Practice a few times with a few companies. I would suggest using my Stock Screener Guide to get a list of companies to value. You can start with that list.

Now that you have the growth rate, you need to input a safety factor into your calculation. The purpose of this is to account for the possibility the company may not grow at the same rate in the future.

Apple Inc. is a great example for this. 25.3% growth rate is a crazy pace for a company to grow. At that rate, they are doubling in size every 4 years! I would say it is very unlikely for Apple to keep up that pace.

Don’t be afraid to subtract 5, 10 or 15% from that growth rate to account for a possible slow down.

Lastly, multiply your earnings growth rates (original and safety rates) by the most current Earnings per share (EPS). You can also find that on Morningstar.com.

Stock Valuation Formula:

Earnings growth rate x EPS = Fair Value Stock Price

Apple Inc. Example:

Original 25.3% x 8.35 = $211.25

Safety 1 20.3% x 8.35 = $169.50

Safety 2 15.3% x 8.35 = $127.75

Safety 3 10.3% x 8.35 = $86.00

There you have it. You have found Apple’s fair value stock price along with some safety estimations.

Stock Valuation Technique:

Apple is currently trading at $129.00 a share. So, at that price, the original valuation of $211.25 would suggest that Apple is a great buy. Basically, you are buying Apple’s shares at a 69% discount.

What should you do if you believe there is a reason Apple won’t grow at the same rate? Well, just use the safety estimates. Maybe Apple experienced legal issues or a great new technology company has increased their competition in the market. Business is an unstable monster, so you must pay attention to those factors.

With that said, a worst-case scenario for Apple really happened and you want to use the third Safety calculation of $86.00 per share. That would mean if you bought Apple’s shares today, then you would be paying 33% more than fair value. It’s a bad buy.

Going Forward…

Buying cheap stocks, to me, is the most important part of investing.

Read this post thoroughly and post comments if you have questions.

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