Stock valuation – Considering risk in a company
When we value stocks, merely looking at the current profitability is insufficient. We also need to consider the risk involved with investing in a particular company.
In other words we need to establish what minimum rate of return we need to get from an investment in a company in order to justify the risk involved. This is known as the required rate of return.
Factors that need to be considered in establishing this return are:
The current risk free rate in government bonds
an additional rate of risk required for investment in the stock market
the specific risk related to a particular company based upon factors within the company and factors in the companies external environment
The sum of all of these elements becomes the required rate of return for a particular stock.
As an example, you may well consider an investment in a resources exploration company to be a much greater risk than that of a food retailer.
This required rate of return, in combination with the financial performance of a company and how much equity was required to generate that performance are the base elements of our intrinsic value calculation.
Read more about Demystifying Required Rate of Return >>
Read an even more detailed run through on valuing companies using the Required Rate of Return >>
If you think that this seems complicated, you’re not wrong. Clime’s analysts use our stock valuation tool, MyClime, to assist with this process, and you can take advantage of this same information as well.
Whether you’re a sophisticated investor or just starting out with investing, you can access Clime’s expert research and insights through Clime’s Investment Products >>