Stock value: how to determine whether shares are overvalued or undervalued

By price, we mean the amount of money a buyer is willing to pay for an asset, although in the stock market world it is not always easy to determine the difference between price and value. However, in the stock market, as in all disciplines, there are a series of “formulas” we can use to gauge whether a security is expensive or cheap. More precisely, there are various online resources that investors can use to trade more rationally in the markets.

How to calculate the value of shares using the PER (Price-Earnings Ratio)

The PER, short for Price-Earnings Ratio, is the go-to indicator in the stock market world. It relates the price at which a share is traded to the earnings generated by that company; it is a simple division of the share price by the company’s net earnings divided by the number of shares.

This calculation gives a number showing the number of years needed to recoup the investment, factoring in the earnings generated. So, the higher the PER, the more investors are paying relative to earnings, while a lower PER indicates a cheaper stock.

The PER does not have universal ranges that allow a stock to be classified as “cheap” or “expensive” on its own. Its interpretation is always relative and should be made by comparing it with companies in the same sector, its historical evolution and growth expectations. A high PER may be justified in companies with strong growth prospects, while a low PER does not always indicate a buying opportunity, but may reflect weaker expected performance or higher perceived risks.

Book value: what it says about the real value of a stock

This variable is not as well known as the PER, but it lets us know what the “real” value of a company is. As the name implies, the book value of a share takes into account how much the assets of that company are worth, based on its accounts. And we don’t just mean its assets, but rather the value of its assets less its liabilities divided by the total number of shares outstanding.

In simpler terms, this means adding up all the company’s assets (buildings, machinery and patents, etc.) and then subtracting its debts. The result would be the book value, which, once divided by the number of shares, tells us what the “real” price is. If it is above the market price, it means that you are buying a share whose intrinsic value is higher. Conversely, if it is below the quoted price, it means that you would be paying extra to acquire the stock.

This variable compared to its market price is known as the price to book (P/B) ratio, the multiple of which indicates how many times the book value (equity value) of the company is trading for on the stock market.

Free cash flow: key to estimating the value of shares

Free cash flow (FCF) reflects the actual cash a company generates after covering its operating expenses and the investments required to maintain or expand its activity. Unlike accounting profit, FCF shows the cash available to reward shareholders, reduce debt or reinvest in the business, providing a more accurate picture of the company’s financial capacity.

In valuation, the most commonly used approach is to estimate future free cash flows and discount them to present value using an interest rate that reflects the risk of the investment. This method, known as discounted cash flow (DCF), is based on the idea that the value of a company—and therefore its shares—depends on the cash it will be able to generate in the future.

Companies with strong and sustainable cash generation tend to have higher value, as they can finance growth, meet their obligations and reward shareholders.

Dividend yield: key to evaluating a stock market investment

Dividend yield is another of the most commonly used variables for comparing a stock’s price and is an absolute must for small investors. This percentage compares the expected dividend per share with the share price. The higher the better, simply put.

Broadly speaking, companies offering a higher dividend yield are a better buy, as the investor will receive more of the profit in the form of dividends. Investors seeking regular dividend payments should keep a close eye on this variable.

In addition to a high dividend yield, investors who want to receive a recurring dividend should pay attention to two other key aspects: whether the shares come from large companies and whether they have a recurring business model.

‘Payout’: how much profit companies deliver to shareholders

The payout is not in itself a stock market ratio, though it does allow investors to know how much of the profit the company is willing to distribute among its shareholders. Listed companies can essentially do two things with their profits:

• Retain them (using them to grow or to continue investing or conducting research)
• Distribute them

For those companies that choose to distribute their earnings among shareholders, it is important to look closely at the percentage they are willing to pay out. This is known as the payout. For instance, if a CEO announces a 20 percent payout, it means that 20 percent of that year’s profit will be distributed among shareholders; if it were 50 percent, it would mean paying out half of the profits.

Earnings per share (EPS): how to measure business profitability

Earnings per share, or EPS for short, is a widely used variable, as it looks at the profit generated by a company divided by the number of shares. The calculation is simple: divide the profit for a given quarter or year by the number of shares at that time. The higher it is, the more profit the company is able to generate per share. Of course, this should always be put into context.

There is also estimated earnings per share, which instead of looking at the company’s actual profit uses expected earnings divided by the number of shares.

Target price: what analysts estimate

On the one hand, we have the market price, which is the price at which the shares are traded and which can be consulted almost in real time on various websites, while on the other, we have the target price, meaning the price that various experts—mainly investment banks and securities firms—assign to the shares. These target prices are based on expert analysis and therefore serve as a useful guide when deciding whether to buy the stock. We could say that it refers to the “fair price” of a stock.

Beta: how to measure risk in share prices

While beta is not a widely used variable, it can be useful in showing the difference between the performance of a stock and the benchmark index. In other words, it shows how a share performs relative to the wider market. Thus, if a stock has a beta of 1, it means that it will behave in exactly the same way as the index. In other words, if the Ibex rises 5 percent and a company has a beta of 1, it will also rise by 5 percent. But if the Ibex falls 10 percent, the company will also fall by that amount.

Therefore, it shows how the performance of a stock correlates with that of the index. If beta is greater than 1, the stock will rise more if the index rises, but it will also fall more if the index falls. Conversely, a beta below 1 means that if the Ibex rises by 10 percent, the stock will rise by less. For example, if a company has a beta of 0.5 and the Ibex rises 10 percent, the company will only rise 5 percent, and the same applies in reverse.

Beta is estimated using historical return series through regression analysis, so its reliability depends on the number of observations used. In professional and academic practice, it is common to use time windows of between one and five years (with daily or monthly data), as shorter periods produce less robust estimates with higher statistical noise. Since this variable is based on past data, the stock may behave differently in the future. Nevertheless, it remains another useful metric to consider when choosing between stocks.

ESG criteria: impact on the long-term value of shares

The integration of ESG (environmental, social and governance) criteria has become an important factor in value creation, as it influences both profitability and the risk profile of companies. According to Morgan Stanley, sustainability forms part of a company’s long-term value strategy by helping to build more resilient, future-ready businesses.

In this context, ESG analysis has progressively been incorporated into valuation models, as it provides additional insight into the sustainability and quality of a business beyond traditional financial data. Companies with strong ESG performance tend to attract greater investment and maintain long-term competitive advantages, reinforcing their intrinsic value and their ability to generate sustainable returns.