When Markets Are Volatile, Measuring Value Is Critical

When markets are volatile, many investors want to understand how they can measure the true value of a stock. Conventional wisdom holds that price-to-earnings (P/E) ratio is the go-to gauge, but there are other options.

P/E ratio compares a company’s share price to its earnings per share, according to Investopedia. It is calculated by dividing market value per share by estimated earnings per share.

What does that mean? The lower the P/E ratio, the “cheaper” a stock, at least in theory. We say “in theory” because in today’s volatile economic and market environment, the “E” in P/E ratio can’t always be trusted. Corporate earnings estimates may be unrealistically high.

That’s why we recommend looking at ways to value stocks that do not involve corporate earnings, such as enterprise value and free cash flow.

Enterprise value calculates the worth of a company based on its entire capital base: short- and long-term debt, preferred stock, and minority interests minus total cash. Including debt is important because it helps investors determine if a company is using debt to inflate its profits.

Free cash flow, meanwhile, takes a company’s earnings and subtracts capital expenditures, thereby revealing the amount of cash a company is able to generate after maintaining or expanding its asset base. This measure thus gives investors an idea of a company’s ability to boost dividends or buy back shares.

If you are investing in stocks when markets are volatile, you may want to determine which of these measures is appropriate for you based on a number of financial measures.

Please reach out to me so I can support you and provide guidance during these unprecedented times.