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Valuation

Valuation is the process of figuring out how much a company (or stock) is worth. It's a way for investors to decide whether a stock is fairly priced, overpriced, or a bargain. Just like you’d want to know what a house or car is worth before buying it, investors look at a company’s valuation to decide if it’s a smart investment.
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Valuation can be approached in different ways, but it often comes down to comparing a company’s price to its fundamentals — like earnings, sales, or growth potential.

Here are some common methods:

  • Price-to-Earnings (P/E) Ratio: One of the simplest tools. It compares the stock price to the company’s earnings per share (EPS). A high P/E might mean the stock is expensive — or that investors expect big growth. A low P/E could suggest it's undervalued — or that growth is slowing.
  • Price-to-Sales (P/S) Ratio: Useful for companies that aren’t profitable yet. It compares stock price to total revenue. Lower ratios may suggest better value.
  • Discounted Cash Flow (DCF): A more advanced method that estimates what the company’s future cash flow is worth in today’s dollars. It’s detailed, but sensitive to assumptions about growth and interest rates.
  • Comparable Company Analysis: Looks at similar companies (in the same industry or size) to see how the company stacks up. It’s like checking what other houses in the neighborhood are selling for.

Valuation helps investors:

  • Decide when to buy or sell: A great company can still be a bad investment if the price is too high.
  • Avoid hype: A soaring stock may be exciting, but if it’s extremely overvalued, a pullback could follow.
  • Spot opportunities: Undervalued stocks (trading below what they’re worth) can offer solid returns — if the market eventually catches on.

However, valuation isn’t an exact science. Different investors use different methods, and markets don’t always behave rationally in the short term.

  • In 1999, many internet stocks were trading at sky-high valuations with little or no profit — leading to the dot-com bubble and crash.
  • In 2008–2009, many solid companies became undervalued due to panic selling — those who bought in saw strong long-term gains.
  • Today, some tech stocks trade at high P/E ratios due to strong growth expectations, while others in mature industries trade at lower valuations with stable dividends.

Valuation is about asking whether a stock’s price makes sense, given the company’s current performance and future potential. It's not just about finding cheap stocks — it's about finding good value.

Investors who understand valuation are better equipped to make smart, strategic decisions — and avoid getting caught up in market hype.