How to Value Stocks (Basic) i.e. using Balance Sheet / Asset Values

Basic Concepts and Easy Step-by-Step Process of Common Stock Valuation by Balance Sheet Analysis

BASIC CONCEPTS (You may skip to the Step-by-step Process below if you wish)

In order to value stocks, we must first know what buying a stock means. A stock is a portion of a business, which is represented as a share of a corporation. A corporation is the legal entity of the business. Therefore, when you buy stocks for investment, you buy a portion of a business and you should view it as such. That is the underlying principle of fundamental investing; looking into business behind the stock. This is in contrast to, for example, trading or technical analysis where the focus of buying and selling is the price of the stock and the patterns it creates, among other things.

How do we make sense of all of this to buy stocks?

Well, we must first
(1) attempt to value the business as a whole, (2) then divide that figure by the number of shares or stock available (outstanding). This will give as an intelligently estimated purchase price PER SHARE of the business.

The most basic form of valuing a business is by looking how much the owners actually spent/invested in the business. For example the utensils, chairs, the ovens, stove, building, land the owners bought before starting a restaurant. These things used in the business are called business ASSETS. These items are listed in the BALANCE SHEET in the corporate FINANCIAL STATEMENTS. These financial statements are released annually or quarterly (every 3 months), and available for free download at the PSE Website.

If there are assets, there are also LIABILITIES which are "utang" or loans or other people's money used in the business.

So looking at how much was actually spent to buy stuff for the business, we will get an idea how much it should be sold if the owner decides to sell his business, or incidentally, if you want to buy his stock.

In calculating how much the stock is worth or BOOK VALUE in the balance sheet, we must:
*Subtract the Liabilities (loans/utang) from the owner's equity/Assets (stuff used in the business, including cash etc.)

EQUITY is another term for the word OWNERSHIP. So in business, owner's equity is the owner's own contribution to the business from his own pocket.

Thus we arrive at the basic formula:

ASSETS - LIABILITIES = Net Asset Value / Book value of business / Owner's Equity

Next step, you simply divide this resulting number by the number of shares available or outstanding shares to get the PER SHARE Price or Per share book valuation of the business/stock.

Step-by-Step Guide
(Images courtesy to PSE, Inc.)

1) Go to PSE website at www.pse.com.ph
2) In the top right corner type in the stock quote of the stock you want to value. Example "CPG" for Century Properties Group.

3) Take note of the number of outstanding shares.

4) Click the Corporate Disclosures tab

5) Download the latest annual report or quarterly report. I suggest annual report because these are comprehensive results for the entire year. These reports contain the financial statements for the period.

6) Find the Balance Sheet part of the Financial Statement.
Subtract Total Liabilities from Total Assets (as described in our concepts above)
(Example taken from CPG, courtesy of Century Properties Group)
ASSETS (total in red box)

MINUS
LIABILITIES (total in red box)

EQUALS
Book Value or Owner's Equity.

This Book Value / Equity Amount is what the owners actually own and invested in the business.


7) To get the PER SHARE amount, simply DIVIDE this number by the number of shares outstanding from Step 3.

You can use this number as a reference or rough guide how much a stock might really be worth. This number is in PESOS, so you can directly compare it to the price of the stock in the market.

(Sometimes, I use the equity minus equity of non-controlling interests)

P.S.

You can also compare this big number (Total Equity, not the per share basis) to the market capitalization, to see how much the market is valuing the entire business as compared to the owner's equity.

 VERSUS 

We see in this example that Market Capitalization (market price x number of shares) is larger than actual owner's equity. This means the market is paying P11 billion for P8 billion worth of business assets.


YOU'RE DONE! Of course Book Value is just one of many ways to value a business and it is also one of the basic. Stay tuned for PART 2, to value stocks using other methods using data such as earnings multiple or P/E.

Thanks for reading, please share to your friends.