Formula
Since share prices are all over the place sometimes, it can be useful to calculate an estimated ideal price. There are many ways to do that but the following method takes the approach of what would the whole company be worth if it was sold today. Here is the basic formula:
Price per Share = (Future Earnings + Assets - Liabilities) / Number of Shares
If you were to buy a company you would want to know how much cash, assets, and debt they had, along with how much profit they were making. You would also be concerned with how much profit they would be making a few years down the road. That is the most difficult part of the calculation because it requires an estimated guess.
How to Find the Numbers
Publicly traded companies are required to post their financial numbers every quarter, so this information is available on most major financial websites, including Yahoo! Finance.
Example - Google (GOOG) for Q1 2009:
Assets: $33.5 Billion (found in the Balance Sheet section as Total Assets)
Liabilities: $3.7 Billion (found in the Balance Sheet section as Total Liabilities)
Number of Shares: 315.9 Million (Market Cap divided by the Current Price)
Earnings for 2006: $3.1 Billion (found in the Income Statement as Net Income)
Earnings for 2007: $4.2 Billion
Earnings for 2008: $4.2 Billion
Earnings for 2009+: $4.0 to 5.0 Billion (this is where you have to guess)
Future Earnings: $90.0 Billion (assuming 20 years at $4.5 Billion per year)
Price per Share = $379.23 = ($90.0 Billion + $33.5 Billion - $3.7 Billion) / 315.9 Million
The Future Earnings is definitely the hardest number to come up with. With a big, solid company like Google you might use 15 to 25 years in your calculation because a P/E ratio (Price to Earnings) of 15 to 25 is pretty common. If you are unsure about the company, you might use 5 to 10 years. The number to use here is based on how long you think the company can keep producing these profits. And of course you have to guess how much profit they will make in each of those years.
The current P/E for GOOG is about 30 right now. If that is factored into our formula, that would give us a price of $521.68. With the current share price between $400 and $420, you can see that our formula gets us in the ballpark, depending on what numbers we use for Future Earnings. Not only is the number of years important but so is the earnings per year. With the United States currently in a recession, Google may not be expected to grow much in the next two years, so that should be factored in.
Sometimes this method is very accurate (close to the real-life price) and sometimes it is way off, so do not count on it as an absolute number. It is just another tool to use when analyzing companies. You can also look at the company's P/E ratio to see if it's in the "normal" range.
Nicholas Swezey helps people to practice forex trading at HowTheMarketWorks.com.
Tags: finance, stock market investing, share prices, stock prices, p e ratio