Sometimes you will hear on a financial show or online about a stock being overvalued.
But how do we know if it’s undervalued or overvalued?
That’s a question that’s often asked and the first thing you need to know is that like artwork or your home which can be appraised in order for it to be sold to the public. And quite often, you’ll have many financial analysts who will give you an intrinsic value of a stock and not everyone is going to have the same type of appraisal.
In fact, I’m going to give you examples and how a stock’s fair value can vary.
So, we are going to take a look at one of the hottest technology stocks right now and that is NVIDIA Corp (NASDAQ: NVDA).
NVDA was priced at $799.40 (as of closing of June 28, 2021) and its increase was +38.16. Not bad as it was $772.76 and around a half hour before close time, it went up to $803.15. But is $799.40 fairly priced, underpriced or overpriced?
So,let’s take a look at it’s annual dividend which is $.64. A yield of a stock goes up when the price goes down. If the price goes up, the yield goes down. Let’s divide that from the price and that would equal yield: $0.64/$799.40 = .08% Yield
NVIDIA was never seen as a dividend stock because dividend investors don’t find .08% annual dividend yield as attractive, but those who invested in NVIDIA for growth, will like the fact that the company puts most of its earnings towards the growth of the company than dividends. The dividend is more like a bonus.
But how do we figure out if a stock is overvalued or undervalued?
So, let’s look at NVDA and get the valuation ratio. The P/E is $90.22 and the Earnings Per Share is $8.44 (rounded off). So, $90.22/$8.44 = 1.09.
So, now to figure out the fair price: $799.40/1.09 = $733.40
And NVDA is trading $66 more than its fair price. So, it’s significantly overvalued. So, what does that mean? It means the long-term return of its stock is likely to be much lower than its future business growth.
Source: Morningstar Equity Analyst Report (on Schwab.com)
II. Morningstar Equity Analyst Report
Morningstar gives their fair value estimate using a discounted cash flow (DCF) model for valuation and many feel DCF is more accurate when it comes to assessing a stock’s valuation. And ignores P/E ratios.
As of June 14, 2021, NVDA was $718.71 and Morningstar Equity Annual Report gave a fair value estimate of $550. Morningstar has NVDA trading $168.71 more than its fair price. Giving the company a 2-Star rating which means its overvalued (1 star meaning extremely overvalued, 5 stars as extremely undervalued).
Using both valuation methods, both show that the stock is overvalued.
Fundamental Analysis by S&P Global Market Intelligence (on Fidelity.com)
III. S&P Global Market Intelligence
But Fidelity uses S&P Global Market Intelligence on their brokerage has had NVDA valued at 49, right in the middle and it’s not overvalued or undervalued and show it as Fair Priced.
So, you get two that show its overvalued and one that shows the stock is fairly priced. Confused?
There are many other ways that financial analysts check to see if a stock is overvalued. Daily Trade Alert uses FastGraphs for their valuations, plus Yield vs. Historical Yield.
Now which do I use?
I make it easier for myself as my brokerages such as Schwab has the Morningstar rating via their Morningstar Equity Analyst Report and Fidelity uses the S&P Global Market Intelligence.
Doing my own due diligence and research to read each observation and report and then decided if I’m willing to invest in the company. Even if they both have different valuations, it’s still good to delve into the data and research it.
Researching a stock is important, because it can get confusing. And because of access to reports, it also is another reason for one to invest in a better brokerage.
As always, do your due diligence. Contact a financial advisor for investing, as they can help you with planning out your investment goals.
