The Six Essential Investment Valuation Methods

Valuation methods refer to the approaches and techniques used to assess the intrinsic value or fair price of an investment. These methods help analysts and investors estimate the true worth of an asset beyond its market price.

Being able to evaluate a company's true value is essential for making profitable stock market investment decisions. In this article, we examine the most important evaluation methods. Here are the six key methods:

1. Revenue Valuation (P/S and Market Share)

2. Earnings Valuation (P/E and P/E/G)

3. Cash Flows (EBITDA and the DCF Method)

4. Dividend Discount Model (DDM)

5. Equity Valuation (P/Bv and ROE)

6. Empirical-Based Valuation

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(1) Revenue-Based Valuations & Market Share

🔒 Reliability: 4/10

In general, a company’s total revenue is generated by selling goods and services. High revenue indicates a strong competitive position. To compare a company’s revenue to its market value, you can use the Price/Sales ratio.

🧮 P/S Ratio = Share Price / Sales per Share (annual sales)

Depending on the industry and the company’s growth rate, the Price/Sales ratio can range from 0.2 to 10, or even 50. A Price/Sales ratio of 0.2 is common for technology stocks that invest heavily in research, while a ratio of 50 is typical for industries with very low growth rates and historically low net profit margins. This evaluation method is mainly useful for newcomers in high-growth industries.

Market Share

Market share refers to the percentage of sales earned by a specific company within a particular market over a period of time. It is considered an indicator of corporate competitiveness, which is why the stocks of "market leaders" often trade at a premium compared to other stocks in the same market.

🧮 Market Share = (Company's Sales / Total Market Sales) × 100

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(2) Earnings-Based Valuation

🔒 Reliability: 7/10

Earnings, also called net profit or net income, are crucial when evaluating a company’s fair value. To compare different shares, Earnings Per Share (EPS) is commonly used. EPS for a given period (usually annually) is calculated by dividing total earnings by the total number of shares outstanding:

🧮 EPS = Total Earnings for a Period / Total Number of Shares

To compare a company’s earnings to its stock price, you can use the P/E ratio, which stands for:

🧮 P/E = Share Price / Earnings per Share (annual earnings)

The P/E ratio is used to evaluate individual stocks, industries, and even entire stock market indexes. In developing economies, the historical average P/E ratio is around 10, meaning investors would wait 10 years to recoup their investment from the company’s earnings. Companies and industries with high growth potential may trade at P/E ratios over 20, sometimes exceeding 50. Those with little or no growth potential may trade at P/E ratios below 4. Note that EPS can refer to either before-tax or after-tax earnings; in the US and Europe, after-tax earnings are typically analyzed.

👉 Notes:

(i) Be aware that EPS sometimes include one-off earnings that won’t be repeated. For example, if a company sells an asset for $100 million but originally spent only $50 million on it, the $50 million gain (before tax) will be added to annual earnings. Such earnings should be excluded from your P/E analysis to ensure accuracy.

(ii) High depreciation expenses can also distort P/E valuations. Companies that invest heavily benefit from deducting depreciation from taxable profits, which can make their P/E ratios misleadingly low. Therefore, companies with heavy investments are generally expected to trade at P/E ratios above their industry average.

P/E/G ratio (Price/Earnings to Growth ratio) 

The P/E/G ratio is a metric based on the P/E (Price-to-Earnings) ratio, but it also takes into account the company's expected earnings growth. It is commonly used in high-growth industries, such as technology stocks, and indicates if a stock is undervalued or overvalued relative to its growth.

🧮 P/E/G = Share Price / Earnings per Share / Growth Rate

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(3) Cash Flows, EBITDA, and the DCF Method

🔒 Reliability: 9/10

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(4) Dividend Discount Model -DDM

🔒 Reliability: 8/10

The Dividend Discount Model (DDM) is an effective method for valuing mature companies with stable or even negative growth rates, such as those in the utilities and communications industries. It values stocks based on future dividends, focusing on concrete shareholder returns. However, DDM often undervalues companies that reinvest heavily for growth. Therefore, it is best used alongside other valuation methods, such as discounted cash flow (DCF) analysis.

🧮 Dividend Discount Model (DDM): Fair Price = D1 / { r - g}​​

Where:

D1 = Dividend expected next year

r = Cost of capital (your discount rate)

g = Average growth rate of paid dividends

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(5) Equity-Based Valuation

🔒 Reliability: 4/10

ROE may indicate management’s talent and ability to generate profits using limited organizational resources. Therefore, companies with high ROE have historically been more attractive to investors than those with average or low ROE.

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(6) Empirical Valuation

🔒 Reliability: 8/10

Empirical valuation models cover a broad area of research and often arise from unpredictable events. These events typically have a strong impact on stock market volatility. For example, after a hostile takeover, investors may buy shares in competing companies within the same industry. If the takeover occurs at a P/E of 20, this becomes an important valuation benchmark for other companies in that sector.

Empirical valuation is also widely used in industries where sales depend on customer accounts or subscribers, such as online services, cable TV, and mobile telecommunications. By analyzing the expected future number of subscribers and their average revenue, you can estimate future revenues with reasonable accuracy. Empirical models can be very reliable and are commonly employed by investment professionals.

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🎯 Final Verdict -Not All Investments Are the Same

There is no single valuation method that works for all investments. The appropriate method largely depends on the growth stage of each industry. For example, when evaluating a technology stock, it’s better to use the P/E/G ratio rather than the classic P/E ratio. Also, using the book value (P/BV) is not very helpful when assessing companies in an early growth stage. Companies that spend heavily on R&D often have weak-looking balance sheets, but that doesn’t mean they lack value. At one time, the balance sheets of Apple and Google looked poor, yet that didn’t stop them from becoming the tech giants we know today.

In contrast, when evaluating mature industries such as banking, real estate, and communications, you should focus more on the balance sheet. For example, when evaluating a bank, you should monitor the P/BV ratio, check the P/E ratio, and pay close attention to the projected dividend policy for the next 2–3 years.

Table: Investment types and typical approaches

Investment Type	Typical Valuation Approach
Innovators (First Movers)	✅ Management's track record ✅ Early-adoption (how many existing clients does the company have?) ✅ Barriers to entry (is there a competitive advantage?)
High-Growth Industries	✅ Market Share + Revenue Multiples ✅ P/E/G ✅ DCF
Cyclical Industries	✅ Market Cap/EBITDA ✅ Dividend Policy for the next 2-3 years
Low-Growth Industries	✅ Market Cap/EBITDA ✅ Dividend Policy for the next 2-3 years ✅ Focus on cash available for potential acquisitions.
Financial Institutions	✅ P/Bv ✅ P/E ✅ Dividend Policy for the next 2-3 years

 

Furthermore, the empirical approach is always useful to confirm your market views. If you can understand empirical data and use it to support your market outlook, you are more likely to make successful investment decisions.

👉 Quantitative analysis should be combined with qualitative analysis.

 

■ Giorgos Protonotarios, for TradingCenter (c)

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