Free Stock Valuation Essay Sample

The Wall Street Journal published an article titled “Stock Valuations Go under the Lens” on 28th September 2014. The article talks about the troubles experienced by stocks during valuation. One of the issues troubling stocks during that period was the pricing of stocks towards perfection. Pricing stocks towards perfection means that the prices of stocks are priced at a very high level such that the gains are dependent on the favorability of the investing environment (Browning, 2014). The investing environment should have low interest rates, continuous global growth, low inflation, and strong corporate profits. A less favorable environment weakens the stocks.
Setting high prices on the stocks creates wide cracks on investments. The stock traders tend to quickly sell their stocks when the prices of stocks are high. Some of the cracks that were spotted by the investors include the uncertainty about China’s economic growth, increased tensions with Russia, and the expected increase of interest rates by the Federal Reserve. These issues make the market more volatile. Dow Jones saw its stock fall by 264 points (Browning, 2014). The falling of the value of the stocks held by Dow Jones made the investors afraid of making losses.
Columbia Management Investment Advisors made the decision of reducing the stocks the company held and opted to increase its cash holdings (Browning, 2014). The move was to give the company the chance to watch out and see whether the stocks were going to stabilize. The company’s management team is optimistic that the stocks will stabilize, but they are afraid that the investing environment is headed towards unfavorable conditions. The company hopes to buy more stocks using its cash holdings once the market becomes stable. The firm uses various methods to measure stock value based on the company’s book value, sales, and earnings. One of the methods that are commonly used is making comparisons between the earnings and the stock prices. The company uses this method by creating a price/ earnings ratio.
The above article compares to the chapter on stock valuation because of the valuation methods used. The chapter on stock valuation gives two approaches that are used in the valuation of stock. These approaches are ratio based approach and intrinsic value approach. An example of a ratio based approach is the P/E ratio. This ratio compares the price of stock to the earnings derived from the stock. The ratio based approach focuses on drawing comparisons between the market value of the stocks and any of the financial aspects of the company’s performance. These aspects include cash flow, book value, sales, and earnings. The ratio based approach is preferred by most companies because it is easy to calculate the ratios. The disadvantage of this method is that a lot of information is required so as to make sense of the ratios used in the valuation process. It is important for a company to know the P/E ratios of its major competitors, the P/E ratios of the market, and the P/E ratios of the company’s past performances. In the article above, we see that the Columbia Investment Management Advisers is a firm that prefers to use the ratio based approach of valuing stock.
The intrinsic value approach involves estimating the stock’s worth. The process involves the projection of a company’s future cash flows. Comparisons are then made between the stocks intrinsic value and the market price of the stocks. These comparisons help in the determination of whether the stock has been fairly valued, overpriced, or underpriced. The advantage of this approach is that it does not require a lot of information to make it understandable as opposed to the ratio based approach. The article above does not mention the use of the intrinsic value approach by the companies. It appears that most companies prefer to use the ratio based approach.

Works Cited

Browning, E. S. Stock Valuations Go under the Lens: With Stock Prices Near ‘Perfection’, Future Gains Need Ideal Conditions. 28 Sep. 2014. Web. 8 Apr. 2015. http://www.wsj.com/articles/stock-valuations-go-under-the-lens-1411950196