Stock Price Calculation Formula
Use this calculator to estimate a stock's fair value based on its earnings and expected growth.
Estimated Fair Stock Price:
Understanding the Stock Price Calculation Formula
The "Stock Price Calculation Formula" most commonly refers to models used to estimate the intrinsic or fair value of a stock. One of the simplest and most widely used is the Dividend Discount Model (DDM), or more specifically, its perpetual growth variant, often referred to as the Gordon Growth Model. This calculator uses a simplified approach related to the earnings of the company, often assuming earnings can act as a proxy for dividends or that the company reinvests earnings at a rate that allows for consistent growth.
The Simplified Formula Used Here (Related to Gordon Growth Model):
The core idea behind these models is that the value of an asset is the present value of all future cash flows it is expected to generate. For stocks, this translates to future earnings or dividends.
The formula implemented in this calculator is a simplified representation, akin to the Gordon Growth Model, which is:
P = E / (r – g)
Where:
- P = Fair Price of the Stock (what we are calculating)
- E = Expected Earnings Per Share (EPS) for the next period. In our calculator, we use the current EPS as a base and assume it will grow. For a more precise model, one might forecast EPS for the next year.
- r = Required Rate of Return. This is the minimum rate of return an investor expects to earn from an investment, considering its risk. It's often derived from the Capital Asset Pricing Model (CAPM) or other risk assessment methods.
- g = Expected Constant Growth Rate of Earnings (or Dividends). This is the rate at which the company's earnings are expected to grow indefinitely.
Important Note: This model is most applicable to mature, stable companies that pay dividends (or have earnings that grow at a consistent rate) and where the growth rate (g) is less than the required rate of return (r). If g is greater than or equal to r, the formula results in an infinite or negative price, indicating the model's limitations or an unsustainable growth scenario.
How to Use the Calculator:
- Earnings Per Share (EPS): Enter the company's reported Earnings Per Share. This is the company's net profit divided by the number of outstanding shares.
- Expected Annual Growth Rate (%): Input the rate at which you anticipate the company's earnings to grow each year. This is often based on historical performance, industry trends, and management forecasts.
- Required Rate of Return (%): Enter the minimum annual return you expect from this investment. This should reflect the risk associated with the stock and your investment goals.
Clicking "Calculate Fair Stock Price" will provide an estimated intrinsic value for the stock based on these inputs and the Gordon Growth Model principle.
Use Cases and Limitations:
- Valuation: Helps investors determine if a stock is undervalued, overvalued, or fairly priced.
- Investment Decisions: Aids in making informed decisions about buying or selling stocks.
- Company Analysis: Provides a framework for analyzing a company's financial health and future prospects.
Limitations:
- Assumes a constant growth rate indefinitely, which is unrealistic for most companies.
- Highly sensitive to the input variables (g and r). Small changes can significantly alter the output.
- Not suitable for companies with erratic earnings, high growth startups, or those not paying dividends/reinvesting earnings consistently.
- The "required rate of return" and "growth rate" are subjective estimates.
For a more comprehensive valuation, consider using multiple models and performing thorough fundamental analysis.