Beating the Market

• Beating the market means to invest at a greater rate of return than is available per the benchmark S&P 500, Dow Jones, and Wilshire indices for a set period of time. Few individual stock pickers--even the professionals--actually outperform the market.
  
  According to Vanguard founder John Bogle's "Common Sense on Mutual Funds," only one out of every six managed equity funds succeeded in outpacing the market's return during the height of the 1982 to 2000 bull market.
  
  Of course, legions of active investors will argue that impressive returns are possible by learning how to value and buy common stock.
  
  

Market Capitalization

• One share of stock represents one partial ownership claim to the equity and earnings potential of a corporation. Market capitalization is calculated by multiplying the individual share price by the total shares outstanding of the corporation. Market capitalization is the stock market's valuation of the entire company.
  
  

Share Price and Price to Earnings Ratios

• Share price alone is arbitrary. Shares of Stock A trading at $50 are not exactly more "expensive" than competing shares of Stock B at $25. A $1,000 investment is still a $1,000 investment, whether it buys 20 shares of Stock A or 40 shares of Stock B. Investors must appreciate corporate structure and the basics of financial statements to determine the real value of shares.
  
  Price to earnings (P/E) is the most basic ratio of value. The P/E is calculated by dividing the current share price by the earnings per share (EPS) of the corporation. Accountants divide the net income of the entire company--in other words, its profit--by the number of shares outstanding to arrive at EPS. The higher the P/E, the more you are paying for each dollar of the company's profits, if there are any.
  
  

Book Value

• Book value, also described as net worth or equity, is defined by subtracting the corporation's liabilities from its assets. That figure is divided by the number of shares outstanding to arrive at a book value per share. Publicly traded stocks that may be bought for less than book value may be fairly described as "cheap."
  
  It's best to be careful with this number, though. Some companies are cheap because they are temporarily undervalued by the market. Others, however, may be cheap for a reason--because they are poorly run, are headed toward bankruptcy, or operate in economic sectors that are likely to perform poorly.
  
  

Intrinsic Value

• Whereas book value signals what is "in" the corporation, intrinsic value describes what can be taken "out" of the business in terms of future earnings. Intrinsic value is calculated by determining the present value of future earnings reinvested at prevailing interest rates. The discounted cash flow formula is [EPS x (1 + Long Term Growth Rate)] / (Discount Rate -- Long Term Growth Rate).
  
  Growth rates are integrated as decimals. Meaning, 3 percent must be converted to 0.03.
  
  Stocks that trade for less than intrinsic value may also be described as "cheap."
  
  

Common Stock Valuation Information

• You can access daily stock quotes and price to earnings in most local newspapers, in the Wall Street Journal or at online sources such as Bloomberg Market Data.
  
  All publicly traded companies will issue annual reports that break down financial information further into net income, balance sheet and cash flow statements that can be used to compare against historical share price data. Annual reports are available through the investor relations department of each corporation.