In this article, we’re going to explore how to calculate stock price using a variety of ways including from:
- market cap (aka market capitalization)
- the PE ratio (and other ‘Multiples’)
- dividends, and
- free cash flow
Let’s get into it!
How to calculate stock price
Before we get into the specifics of how to calculate stock price though, let’s be clear on what the stock price is.
What is stock price?
Stock price refers to the current market price of a stock or share. It’s the price at which the stock trades at in the financial market.
There are a variety of ways to calculate the stock price, so let’s now look at the different ways.
How to calculate stock price based on market cap
We can calculate the stock price by simply dividing the market cap by the number of shares outstanding. In other words, we can stay that the Stock Price is calculated as…
Let’s now think about why we can calculate it this way.
The Market Cap (aka Market Capitalization) reflect the market value of the equity of the company. It’s calculated as…
Where refers to the Stock Price, and reflects the total number of shares outstanding.
We can rearrange the equation for market cap to obtain an expression for the stock price. This is done by dividing both sides of the equation by , resulting in…
Okay, so you now know how to calculate stock price based on market cap. Let’s now consider a different approach.
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How to calculate stock price from PE ratio (and other Multiples)
Described as the “investor’s darling ratio”, the PE ratio (or Price to Earnings Ratio) is one of the most popular investor ratios. The PE ratio is calculated as…
Where reflects the stock price, and reflects the Earnings Per Share. Using a similar approach we took when we learned how to calculate stock price based on market cap, we can rearrange the PE ratio equation to obtain an expression for the stock price.
This is done by multiplying both sides by the so that we have…
The same holds for other Multiples or ratios. For example, if we think about how to calculate stock price based on revenue multiples, we’d start by identifying a relevant revenue-based financial ratio.
Let’s consider the Price to Sales ratio (PS Ratio), estimated as…
Here reflects the stock price as before, and displays the Revenue Per Share.
We can now rearrange the PS ratio to obtain an expression for the stock price as…
How did we get this? By simply multiplying both sides of the PS Ratio formula by the .
How to calculate stock price from dividends
In addition to price based multiples, we can also use dividend ratios and rearrange them to obtain an expression for the stock price.
Take the dividend yield for example. It’s calculated as follows…
Where and reflect the Dividend Per Share, and as before, represents the stock price.
Here again, the approach on how to calculate stock price from dividends is pretty similar to the approaches we’ve seen earlier. Fundamentally, it’s just a simple case of rearranging the equation. In this case, we can rearrange the equation as…
Incidentally, this equation is actually similar to the (famous) Dividend Discount Model (DDM)!
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The DDM in its simplest form, expresses the price of a stock as…
Here refers to the dividend per share, as above. And refers to the cost of equity. And while there are many ways of estimating the cost of equity, for example, by using the Capital Asset Pricing Model (CAPM), it can also be proxied by the dividend yield.
Put differently, the dividend yield can be seen as an appropriate measure of the cost of equity. In other words…
Importantly, that’s just one way to estimate the cost of equity. It’s not the only way by any means. The other ways are a whole other topic that we’ll save for another time, another day.. For now, let’s think about how to calculate stock price from free cash flow.
How to calculate stock price from free cash flow to equity
In the “realm of cash flows”, there are broadly 2 kinds, including:
- free cash flow (FCF), and
- free cash flow to equity (FCFE) (aka “flow to equity”, “FTE”)
While FCF is cash flow that’s freely distributable to debt as well as equity investors, FCFE is cash flow that’s freely distributable to equity investors exclusively.
It’s very common for Discounted Cash Flow (DCF) valuation models to work with free cash flow and free cash flow to equity. If you’re looking to estimate the stock price from free cash flow, then you’re probably better off using FCFE.
That’s because, again, FCFE relates exclusively to equity investors, whereas FCF relates to both debt as well as equity investors.
Remember, stocks are equity instruments. So you’ll ideally want to work with an equity-related cash flow.
You can also estimate the stock price using free cash flow, but you’ll need to make further adjustments and corrections in the model. Essentially, you’ll need to subtract or remove the debt from your estimate of the company to get to an estimate for the equity. And you’ll then take that equity estimate as your core proxy to estimate the stock price.
In a nutshell though, you can calculate stock price from free cashflow to equity as follows:
Hopefully, you now know how to calculate stock price quickly and easily. Note that there is in fact a lot more to it than what we’ve shown. For example, how do you know what the “right” free cash flow to equity value is? Or what the “correct” dividend value is? And indeed, how do you know what the correct cost of equity is.
These are interesting and important questions. And the truth is, there’s no one single correct answer for these questions. But it’s important to ask these questions nevertheless.
If you want to learn how to value stocks rigorously, and you want to build your own robust stock valuation system, then you should definitely check out the course below.
That’s a wrap from us for now though. Keep loving and learning Finance!
Related Course: Stock Valuation (using Multiples)
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