Calculating Stock Price Formula

Stock Price Valuation Calculator

function calculateStockPrice() { var currentEPS = parseFloat(document.getElementById("currentEPS").value); var growthRate = parseFloat(document.getElementById("growthRate").value); var requiredReturn = parseFloat(document.getElementById("requiredReturn").value); var resultElement = document.getElementById("result"); if (isNaN(currentEPS) || isNaN(growthRate) || isNaN(requiredReturn) || currentEPS <= 0 || growthRate < 0 || requiredReturn <= 0) { resultElement.innerHTML = "Please enter valid positive numbers for all fields."; resultElement.style.color = "red"; return; } var growthRateDecimal = growthRate / 100; var requiredReturnDecimal = requiredReturn / 100; if (requiredReturnDecimal <= growthRateDecimal) { resultElement.innerHTML = "Required Rate of Return must be greater than the Growth Rate for this model."; resultElement.style.color = "red"; return; } var nextYearEPS = currentEPS * (1 + growthRateDecimal); var calculatedStockPrice = nextYearEPS / (requiredReturnDecimal – growthRateDecimal); resultElement.innerHTML = "$" + calculatedStockPrice.toFixed(2); resultElement.style.color = "#007bff"; }

Understanding the Stock Price Valuation Formula

Estimating the intrinsic value of a stock is a cornerstone of fundamental analysis. While market prices fluctuate based on supply and demand, an intrinsic value calculation attempts to determine what a stock should be worth based on its underlying financial performance and future prospects. This calculator uses a simplified version of a Discounted Earnings Model, which is conceptually similar to the Gordon Growth Model (Dividend Discount Model) but applied to earnings.

How the Formula Works

The formula used here to estimate a stock's intrinsic price is:

Estimated Stock Price = (Next Year's Earnings Per Share) / (Investor's Required Rate of Return – Expected Annual Earnings Growth Rate)

Where:

• Next Year's Earnings Per Share (EPS) is calculated as: Current EPS * (1 + Expected Annual Earnings Growth Rate).

This model assumes that a company's earnings will grow at a constant rate indefinitely and that these earnings are a primary driver of shareholder value. It discounts these future earnings back to the present to arrive at a fair value.

Key Components Explained:

• Current Earnings Per Share (EPS): This is the company's net profit divided by the number of outstanding shares. It's a fundamental measure of a company's profitability on a per-share basis, usually found on the income statement or financial reports.
• Expected Annual Earnings Growth Rate (%): This is the anticipated rate at which the company's earnings are expected to grow each year. This can be derived from analyst estimates, historical growth rates, or management guidance. It's a crucial input as higher growth generally leads to a higher valuation.
• Investor's Required Rate of Return (%): Also known as the discount rate, this is the minimum rate of return an investor expects to receive for taking on the risk of investing in the stock. It reflects the opportunity cost of capital and the perceived risk of the investment. A higher required return will result in a lower estimated stock price.

Example Calculation:

Let's use the default values in the calculator:

• Current Earnings Per Share (EPS): $5.00
• Expected Annual Earnings Growth Rate: 8% (or 0.08)
• Investor's Required Rate of Return: 12% (or 0.12)

1. Calculate Next Year's EPS:
   $5.00 * (1 + 0.08) = $5.00 * 1.08 = $5.40
2. Calculate Estimated Stock Price:
   $5.40 / (0.12 – 0.08) = $5.40 / 0.04 = $135.00

Based on these inputs, the estimated intrinsic stock price would be $135.00.

Limitations and Considerations:

While useful, this model has several important limitations:

• Constant Growth Assumption: It assumes earnings will grow at a constant rate indefinitely, which is rarely the case for real-world companies. Companies often experience varying growth rates over different periods.
• Sensitivity to Inputs: The output is highly sensitive to small changes in the growth rate and required rate of return.
• Required Return > Growth Rate: The model mathematically requires the required rate of return to be greater than the growth rate. If growth exceeds the required return, the formula yields a negative or undefined result, indicating the model is not suitable for such scenarios (e.g., high-growth startups).
• Focus on Earnings: It primarily focuses on earnings and doesn't explicitly account for other factors like dividends, debt levels, or specific industry dynamics, although these can be implicitly factored into the growth rate and required return.

This calculator provides a simplified valuation. For a comprehensive analysis, consider using multiple valuation models and a thorough understanding of the company's financial health and market position.