Discounted Cash Flows Calculator

This calculator finds the fair value of a stock investment the theoretically correct way, as the present value of future earnings. You can find company earnings via the box below.

Price to Earnings Ratio Calculator

Although discounted cash flows is the correct way to value a company, people naturally like to use simpler rules of thumb. The P/E ratio is the most popular because it's easy to understand. If you buy stock at a P/E ratio of 15, say, then it will take 15 years for the company's earnings to add up to your original purchase price - 15 years to "pay you back". That's assuming that the company is already in its "mature" stage, where earnings are constant.

Let's make that last paragraph a little more accurate. If you actually use the discounted cash flows formula on a zero growth company, you find that its fair P/E ratio equals 1/R, where R is the discount rate. So, using a discount rate of 11%, you find that the fair P/E for a mature company is 9.09.

Of course, you'd be willing to pay a higher P/E ratio if earnings were growing - the payback time would be quicker. And you'd want to pay less if future earnings looked risky to you for some reason.

This calculator lets you find the relationship between growth rate and the fair P/E ratio. (It's the same calculator as before, but rearranged to express the answer as a P/E ratio rather than a share price.)

Projected Earnings Growth (PEG) Ratio

The PEG approach is a simple valuation tool, popularized by Peter Lynch and The Motley Fool among many others. Here is how Lynch puts it in One Up on Wall Street:

"The p/e ratio of any company that's fairly priced will equal its growth rate."

In other words,

P/E   =   G

where P/E is the stock's P/E ratio, and G is its earnings growth rate.

It looks simple and elegant, like a finance version of e = mc², but watch out - this formula is strictly a rule of thumb, not a valid financial "law". (If you aren't convinced, just notice that the two sides of the formula have different units: you're comparing a fraction with a percent, meaning that a factor of 100 has magically appeared on one side only.)

So how accurate is this rule of thumb? It's certainly way off for at least some cases; for example, it implies that a company with zero growth should sell for a P/E of 0. But for normal values of growth stocks, this formula works surprisingly well. This calculator lets you compare the PEG approximation with the "correct" results from the cash flows calculator for different rates of "G":

Capital Asset Pricing Model (CAPM) Calculator

Valuation with the Capital Asset Pricing Model uses a variation of discounted cash flows; only instead of giving yourself a "margin of safety" by being conservative in your earnings estimates, you use a varying discount rate that gets bigger to compensate for your investment's riskiness. There are different ways to measure risk; the original CAPM defined risk in terms of volatility, as measured by the investment's beta coefficient. The formula is:

K_c   =   R_f   +   beta x ( K_m - R_f )

where

K_c is the risk-adjusted discount rate (also known as the Cost of Capital);
R_f is the rate of a "risk-free" investment, i.e. cash;
K_m is the return rate of a market benchmark, like the S&P 500.

You can think of K_c as the expected return rate you would require before you would be interested in this particular investment at this particular price. The idea is that investors require higher levels of expected returns to compensate them for higher expected risk; the CAPM formula is a simple equation to express that idea.

Here is a calculator to let you try it out. You can find values for beta via the box below.