While valuing a company is not an exact science, with there being many ways and means of assessing how cheap or expensive a company's shares are, it is a useful way to improve your long run returns. After all, if you pay too much even for a great company with a bright future, its share price performance may not be as impressive as you had hoped for.
Of course, some stocks may appear expensive or cheap at first glance, but turn out to have been quite the opposite a number of years down the line. For example, a stock may have a high price to earnings (P/E) ratio or a high price to book (P/B) ratio, but offer tremendously strong growth prospects which causes its share price to be bid up by investors. Similarly, a stock may be cheap for a reason and its bottom line (and share price) may disappoint over the medium term.
Overpriced?
One example of a company that seems to be somewhat overpriced is pharmaceutical play, CSL Limited (ASX: CSL). Its shares have risen by 171% in the last five years, and its current P/E ratio of 23.7 appears to be somewhat rich while the ASX has a P/E ratio of 16.7. However, CSL is a different beast to the ASX. For example, it is far more defensive than the wider index, with its value being determined less by falls in commodity prices or concerns about the performance of the domestic economy, and more by its own financial performance.
And, on that front, CSL is performing extremely well. In the last year its earnings have risen by 9% and, looking ahead, they are forecast to rise by 20.2% per annum during the next two years, which makes CSL's current share price appear reasonable.
Similarly, Newcrest Mining Limited (ASX: NCM) has soared by 24% so far this year and a key reason for this is its highly efficient business model and cost-cutting; both of which look set to push its profitability north by 75% over the next two years. As such, and while the price of gold could prove to be somewhat weak as a global financial meltdown appears less likely (investors have historically bid up the price of gold when fear dominates the global economy), Newcrest's surging bottom line and price to earnings growth (PEG) ratio of 0.65 indicate its shares are great value.
Also trading at a premium to the ASX is packaging company, Amcor Limited (ASX: AMC). It trades on a P/B ratio of 7.9, which is vastly higher than the ASX's P/B ratio of 1.27, and also less appealing than the wider materials sector P/B ratio of 0.67. However, that's at least partly because Amcor's share price has risen by a third in the last year, with it set to deliver impressive growth numbers due to its exposure to fast-growing economies, as well as a boost from a weaker Aussie dollar, too. Furthermore, Amcor has a beta of 0.9, which provides a less volatile shareholder experience for its investors.
